Thursday, August 10, 2006

RBC Buys Flag Financial Corp

Financial Post, Duncan Mavin, 10 August 2006

Royal Bank of Canada jumped back into growth mode in the United States yesterday with its purchase of Atlanta-based Flag Financial Corp. for US$456-million.

The deal is the first acquisition since 2003 by RBC's U.S. retail banking subsidiary, North Carolina-based RBC Centura. The deal appears to mark the end of a couple of years of stalemate at RBC Centura, which has suffered disappointing results since recording a loss in 2004.

"This acquisition supports RBC Centura's overall strategy of disciplined, affordable, add-on investments to expand our distribution network," said RBC Centura chief executive Scott Custer.

The deal also signals RBC Centura is following the lead of bigger players in the U.S. banking sector that are targeting branch-network growth by gobbling up smaller regional banks.

Already this year, U.S. giants Capital One Bank, JP Morgan & Co. and Wachovia Corp. have added hundreds of new branches through acquisitions.

Toronto-Dominion Bank, through its TD Banknorth subsidiary in the U.S. northeast, has also increased its branch network significantly, while Bank of Montreal's Chicago-based Harrisbank is reported to be on the prowl for acquisitions too.

RBC's acquisition is not on the same scale as the expansion of some of the largest U.S. banks -- the deal adds just 17 full service branches and five mortgage offices in Atlanta to the bank's existing network of 30 branches in Georgia.

"[But] it makes absolutely perfect sense for [RBC's] U.S. franchise," said Kevin Reynolds an analyst at Stanford Financial Group who covers Flag Financial.

By acquiring a small number of branches in a strong Atlanta banking market, RBC is "dipping its toe in the water and finding a quality franchise that seems to fit with its way of doing business," he said.

The deal means RBC Centura increases its deposit balance by approximately US$1.35-billion, or 12%, and its loans will grow by US$1.25-billion, or 10%.

RBC Centura also gets 370 new employees and customer relationships with about 22,000 households, as well as a beefed-up presence in the region.

"This transaction can be viewed as a bolt-on to Centura's market position in Georgia," said Desjardins Securities analyst Michael Goldberg in a note. "Most importantly, it gives Centura a stronger footprint to further grow in Atlanta," he said.

Some observers believe the U.S. banking industry is ripe for further consolidation because smaller banks are facing a challenging environment.

Intense competition coupled with rising interest rates have reduced the spread between the rates charged on loans and what banks have to give to lure deposits, known as the net interest margin.

That has left bigger players chomping at the bit as they wait for smaller targets to put themselves up for sale.

"Like most U.S. regionals, Flag has struggled with [net interest margin] compression," said Genuity Capital Markets analyst Mario Mendonca.

RBC's purchase of Flag Financial may signal that smaller players are beginning to feel the pinch and further deals could be possible, he said.

However, there was no sign of that trend in the price RBC has agreed to pay for Flag, said Tom Kersting, an analyst at Edward Jones.

"The price seems reasonable," said Mr. Kersting. "Even though the industry conditions are becoming increasingly difficult, it doesn't seem to have really impacted the price."

Nevertheless, at about eighteen times estimated earnings for 2007, most analysts agreed the price for Flag is comparable to recent deals for banks of a similar size.
The Globe and Mail, Sinclair Stewart, 10 August 2006

Royal Bank of Canada is spending more than half a billion dollars to acquire an Atlanta-based retail banking group, kick-starting a U.S. expansion drive that has been largely idle for the past few years.

The country's largest bank is paying $456-million (U.S.), or $510-million (Canadian), for 17 branches operated by Flag Financial Corp.

While not a huge deal, it does represent RBC's first retail acquisition south of the border since the summer of 2003, and suggests the bank has not wavered on its strategy despite some well-publicized struggles in that market.

"This seems to be an attempt to move forward, slowly," said one analyst who follows the bank. "It's a sign that RBC is definitely not retreating from the U.S."

RBC has been a reluctant deal maker in the United States of late, preferring instead to address some performance issues at RBC Centura, its North Carolina-based retail bank, and rid itself of a problematic mortgage division.

Even though much of that work has been done, and the U.S. operations have demonstrated improvement, RBC chief executive officer Gordon Nixon has continued to preach patience on expansion, saying that regional banks are too expensive.

The Flag acquisition was certainly not viewed as a bargain on Bay Street, given that RBC is paying roughly 20 times the company's projected profit for 2006.

Strangely, however, it isn't paying much of a premium on Flag's share price. That's because Flag's stock has been on a tear, climbing roughly 23 per cent in the past month and suggesting to some observers that word of the deal had leaked into the marketplace.

Scott Custer, CEO of RBC Centura, said all regional banks have enjoyed a lift in valuation in recent weeks, and chalked up some of the stock movement to better-than-expected quarterly results reported by Flag.

He also insisted that the price of the deal was in line with what other banks in the area have fetched from suitors.

"It is expensive," he acknowledged of the current market. "That's why you don't try to buy everything that's got a 'For Sale' sign in front of it."

Mr. Custer, who took over the role two years ago, said RBC Centura has made good progress on addressing some of the issues that hurt its profitability, and is now at a point where it can make acquisitions, rather than just grow through new branch openings.

Flag has 370 employees and deposits of $1.35-billion (U.S.) drawn from across Georgia, where RBC has 30 banking centres. Flag will help boost RBC's presence in the southeastern region, but it still remains a small player there.

The last time RBC bought a U.S. retail bank was in the summer of 2003, when it paid $75-million for a group of Florida branches owned by Provident Financial Group Inc. However, the bank hasn't made a U.S. deal of this size since it acquired brokerage Tucker Anthony Sutro in 2001 for almost $600-million.

Mr. Custer said he hopes he doesn't have to wait another two or three years before making another acquisition, but he conceded the bank has to demonstrate it can digest U.S. purchases -- one of the key knocks against it and the Canadian banking industry in general -- before it begins hunting for another deal.

"The easy part is figuring out how to buy something," he said.

"The hard part is figuring out how to run it once you've bought it.
Canadian Press, Rita Trichur

Royal Bank of Canada, the country's biggest bank, is ramping up its presence in the southeastern United States by paying $456 million US through a U.S. subsidiary for Flag Financial Corp. and Flag Bank in Georgia.

The deal marks RBC Centura Banks Inc.'s first U.S. acquisition since late 2003, in a lucrative market that has proved challenging in the past.

"We've got a good presence here in Atlanta but ... this essentially more than doubles our business base here," said Scott Custer, CEO of RBC Centura, in an interview from Atlanta.

"Flag Bank's presence in Georgia, combined with its distinct business banking capability, are ideally aligned with RBC Centura's strategic focus to become the bank for business, business owners and professionals."

The acquisition - which is expected to close by the end of the year, subject to regulatory and shareholder approvals - amounts to $25.50 per Flag share.

Flag Financial owns and operates Flag Bank, which has 17 branches and 370 employees serving about 22,000 households in metropolitan Atlanta and the central and western areas of Georgia.

Flag Bank has a deposit balance of about $1.35 billion US and loans totalling $1.25 billion.

Its branch offices will join a network of 30 RBC Centura banking centres already in Georgia, primarily in the Atlanta area.

After the transaction closes, Centura will merge Flag Bank into RBC Centura. Flag Bank's branch network will operate under the RBC Centura brand name, with current Flag Bank CEO Thomas Wiley as the Georgia state president of RBC Centura.

But the American market has proved tricky for Canada's largest bank. In 2005, it exited its U.S. mortgage business after suffering operational challenges in that division.

"After taking their lumps, they appeared to get it (their U.S. operations) turned around - much to a lot analysts' surprise," said John Kinsey, a portfolio manager with Caldwell Securities.

During its last quarter, RBC's U.S. and international banking arm pulled in $106 million versus $82 million a year earlier, although the strength of the loonie held down U.S.-dollar-denominated earnings by $35 million. The bank is scheduled to report its third-quarter earnings Aug. 25.

"We're just a different company than we were two years ago. And we're much more able, I believe, to execute on an acquisition of this size and ultimately any other acquisition that we might do," Custer said.

The bank, he added, is continuing with its U.S. branch-build strategy and will open four new Atlanta locations in the next 45 to 60 days.

Atlanta, a metropolis of more than five million people, is considered the No. 1 growth market in the U.S. southeast.

"It's a market that a lot of banks have focused on, so it is a little more competitive with newer entrants," said Tom Kersting, a financial services analyst with brokerage Edward Jones.

"But it does appear to be sort of an under-banked market compared to some of the other markets, especially for a large metropolitan area."

In addition to RBC Centura, Royal Bank's U.S. operations include RBC Dain Rauscher, a full-service securities firm based in Minneapolis; RBC Insurance, a national provider of insurance protection and asset accumulation solutions based in Greenville, S.C. and RBC Capital Markets, with corporate and investment banking operations in New York, Minneapolis and Greenwich.
Bloomberg, 9 August 2006

Royal Bank of Canada, the country's biggest bank, agreed to buy Flag Financial Corp. for about $456 million, making its first purchase of a U.S. bank in almost three years as it moves to expand in Georgia.

Shareholders of Atlanta-based Flag Financial will receive $25.50 a share, Toronto-based Royal Bank said today. The bid was 17 cents higher than yesterday's closing price for Flag shares.

Royal Bank has scaled back acquisitions at its RBC Centura unit, based in Rocky Mount, North Carolina, after a 2004 slowdown in the U.S. led to the company's first annual profit decline in four years. RBC Centura bought the Florida branch network of Provident Financial Group Inc. in November 2003 for about $80 million.

``We've been very focused on turning our performance around and earning the credibility that we needed to be able to be back in the acquisition business,'' RBC Centura Chief Executive Officer Scott Custer said today in a telephone interview.

Flag Bank has 17 branches in Atlanta and other parts of Georgia, the banks said in a statement. It has about $1.35 billion in deposits and 370 employees. Royal Bank's RBC Centura unit has 30 branches in Georgia, mostly around Atlanta.

``Atlanta's got some of the best growth demographics, not only in the U.S. Southeast, but in the whole country,'' said Custer, 49.

The Flag branches will be operated under the RBC Centura name. The transaction is expected to close this year.

RBC Centura plans to add 20 new branches by the end of 2007 to its network of about 270. Custer said the bank will continue to consider acquisitions in Georgia, Florida and the Carolinas, although he declined to say how much the bank will spend.

``There's no shortage of smaller community banks that continue to open and probably put themselves out there to be acquired or merged,'' Custer said.

Shares of Royal Bank fell 10 cents to C$46.66 at 4:10 p.m. in trading on the Toronto Stock Exchange. Flag shares fell 66 cents, or 2.6 percent, to $24.67 in Nasdaq trading.
RBC Capital Markets, 9 August 2006

• No Change to Estimates. This deal is not material to overall EPS. Accordingly, we are making no estimate changes and reiterate our Outperform rating.

• Deposits Up 12%, Loans Up 10%. Flag Bank adds 17 branches, (8 in Atlanta), US$1.35B in deposits and US$1.25B in loans. RBC Centura has 274 branches (30 in Atlanta), and ~US$11B in deposits. RBC Centura’s pro forma deposit base increases by 12%, loans by 10% and branch count by 6%. According to SNL Financial data, this should move RBC Centura into 8th place in Georgia and 7th in Atlanta (by deposits).

• Flag is a Commercial Real Estate Lender. Flag’s loan portfolio is 91% in real-estate loans. Construction and land development accounts for 39% of total loans, while another 51% is secured mortgage loans.

• Valuation. Our $55 price target is set at 14x our 2007 cash EPS estimate of $3.94. Our premium target P/E is based on high-quality EPS revisions potential, best-in-class ROE and excellent credit performance. RBC has an excellent business mix with high-quotient of retail business, augmented by leading positions in both wealth and insurance. Our price target is indicated at ~3.1x our projected book value of $17.51 (as at April 30/07).
BMO Capital Markets, 9 August 2006

Royal Bank announced this morning that it has signed a definitive agreement to acquire Flag, a 17-branch bank in Georgia for US$456 million. RBC Centura already operates 30 branches in Georgia, principally Atlanta. The acquisition price is high (20.2x forecast 2006 earnings, 4.7x tangible book value) but this reflects good growth opportunities in the U.S. South and Flag’s high average deposits per branch. The pro forma market share of Royal Bank in Atlanta will be 1.9% and the combined entity will be the 7th largest bank in that market. Despite the price, and the checkered track record of Royal in U.S. retail banking, we believe this is a slightly positive deal. Royal’s franchise in Canada is in great shape, its ROE is impressive and the bank’s stock has performed well. Having said that, we believe the bank needs to improve the scale, competitive position and profitability of its U.S. franchises if it is to have good long-term growth potential. This is a small step in the process for Royal Bank.
The Globe and Mail, Richard Blackwell, 9 August 2006

A U.S. subsidiary of Royal Bank of Canada has signed a deal to buy Georgia-based Flag Financial Corp. for U$456-million.

RBC Centura Banks Inc., Royal's U.S. arm that is based in North Carolina, will pay Flag Financial shareholders $25.50 per share for the retail banking operation.

Flag Financial has 17 Flag Bank branches and five mortgage offices in Atlanta and central and western regions of Georgia. It has 370 employees, deposits of about $1.35-billion and loans of about $1.25-billion.

Flag Financial also operates a payroll service businesses for clients across the United States.

Flag Bank will be merged into the RBC Centura operations, and take the RBC Centura name. RBC Centura already has 30 banking centres in Georgia, mostly in the Altanta area.

The deal need approval by regulators in Canada and the United States, and by Flag Financial shareholders. RBC said it hopes to close the deal by the end of 2006.