Monday, September 25, 2006

TD Banknorth in the US Northeast

(AP) -- A Ryan Beck analyst on Monday downgraded a slew of banking companies, said the industries faces obstacles ranging from an inverted yield curve to slowdowns in auto sales and the housing market.

Analyst Jacqueline Reeves downgraded TD Banknorth Inc. to "Underperform" from "Market Perform" because she thinks the bank's parent, Toronto-Dominion Bank, is going to keep buying U.S. banks. TD Banknorth should trade at a discount to other banks because of the risks posed to earnings from integrating more acquisitions.
Analyst Anthony R Davis of Ryan Beck & Co downgrades TD Banknorth from "market perform" to "underperform." The target price is set to $29.

In a research note published this morning, the analyst mentions that the company has pre-announced its 3Q06 EPS significantly short of the consensus due to slowing fee income and loan growth. The downgrade in the rating is based on valuation, the analyst adds. Ryan Beck & Co expects TD Banknorth’s cash EPS to decline by 12% in the current year, partly on account of increased operating expenses and additional margin compression.
Duncan Mavin, Financial Post, 23 September 2006

Ridgefield, Conn. - Once-rural Fairfield County, Conn., today is littered with chic little towns crammed with bistros and high-end delicatessens, spas and art galleries.

It's one of the richest counties in the wealthiest country in the world, thanks to an influx of commuters from New York City -- less than a couple of hours' drive away -- and executives from nearby corporate offices belonging to IBM Corp. and Pepsico, for instance.

Average household income in Connecticut is US$63,500, well above the U.S. national average of US$49,700. In Fairfield County, which borders New Jersey and is closest to Manhattan, incomes are even higher -- they often range from US$100,000 to US$200,000, compared with about US$40,000 in areas further to the east.

It's no surprise, then, that retail banks are desperate for a piece of the action in an area local banking executives call the "Gold Coast." None more so than Toronto-Dominion Bank's U.S. subsidiary, TD Banknorth.

As its Canadian parent searches for new sources of profit away from the overcrowded domestic battleground, Portland, Me.-based TD Banknorth has targeted the U.S. Northeast for a major chunk of its growth in the next several years.

TD is not alone in looking for growth outside its home territory. Canadian banks are sitting on piles of cash and the quest for growth has taken the banks to unchartered territory, and each bank has its own story to tell. Bank of Nova Scotia is in Latin America and Central America; Bank of Montreal says it is poised to add to its Harrisbank in the Chicago area; Royal Bank of Canada recently added to its RBC Centura franchise with an acquisition in the Atlanta area; and even cost-cutting Canadian Imperial Bank of Commerce is doubling its presence in the Caribbean later this year.

"Twenty years ago, the Canadian banks were world-class banks," Bill Ryan, TD Banknorth's straight-talking chief executive, told a conference in Boston last week. But the Canadians have slipped, especially because merger restrictions have prevented significant growth at home. Instead, the only way to expand is to look abroad -- and with 9,000 banks, the United States has plenty of targets, Mr. Ryan said.

TD's U.S. focus, through 56%-owned TD Banknorth, is mostly in the Massachusetts, Connecticut and metro New York areas. By acquiring one to two banks a year for the next several years, the bank hopes to boost assets to between US$60-billion and US$100-billion, a significant jump from its US$40-billion in assets today, and a far cry from the US$2-billion it had in 1991.

"We did the deal [with TD] to get their capital to acquire more companies, and they did it to use their capital," Mr. Ryan told the conference. "We [TD and TD Banknorth] are both out to make money. We are both out to grow our customers."

TD Banknorth picked up a slice of the coveted Connecticut market in January when it acquired Mahwah, N.J.-based Hudson United Bancorp for US$1.9-billion. The deal brought it 43 branches in the state and US$1.6-billion in deposits -- of which 19 branches and US$757-million of deposits were in Fairfield County.

TD Banknorth's incursion into the riches of Fairfield County and other wealthy parts of the northeast U.S. isn't without its challenges -- intense competition in the region is perhaps chief among them.

TD Banknorth now owns 17 branches within a 15-mile radius of Ridgefield, one of the toniest towns in this affluent county. But inside Ridgefield -- where townsfolk pay Manhattan prices at glass and chrome sushi restaurants and upscale furniture stores -- there are already 14 banks, some with multiple branches, serving a town with a population of only 24,000.

Everyone in the industry knows the area is "overbanked and overbranched," says Gary Smith, president of locally based Ridgefield Bank. The expansion of bank branch networks in the area has been "like watching water boil," says Mr. Smith. "First it gets warm, then it gets warmer, then it gets hot, and then it starts to boil. This has been going on for the last 20 years, but it's really boiling now."

Still, the acquisition of Hudson United has established TD Banknorth as a Connecticut player, says Mr.Smith. "They're now in the ball game in the richest county in the nation," he says.

Indeed, if you are a local, regional or even national bank president, you wouldn't want to be left out -- Realtors like Sotheby's International on Danbury Road don't put dollar figures on the lists of houses they are selling, but the generally accepted starting price for a home here is US$700,000, and most cost well over a million dollars.

"There was a time when there were far more gas stations in town than banks," says Mr. Smith. "Now there are far more banks than gas stations. And it isn't that people are using less gas," says Mr. Smith. "If you were to go back five or six years in Ridgefield, there might have been a thousand households per bank. Now there might be eight hundred."

Ridgefield bank is a white-shuttered red-brick colonial style mansion with plush carpets, cozy armchairs and bronze ornaments overseeing the edge of a town where Mr. Smith himself is head of the local

Lions club and other employees are prominent in local organizations.

His analysis of the number of households per bank spots the trend, but it's already out of date according to statistics from the local chamber of commerce -- there are only 650 households per bank in Ridgefield at last count, in 2005.

There are so many banks here now the town no longer allows more than one on any block -- finding the right locations in such a saturated market is just one of the problems for a growing bank, admit TD Banknorth executives.

In fact, the bank is facing "fierce" competition throughout the territory it covers right now.

Mark Wetmiller is chief retail banking officer at TD Banknorth. On his office wall in Portland, Me., a map shows the bank's "footprint" stretching from the border with Quebec and New Brunswick down past New York City. It is littered with dots locating TD Banknorth's almost 600 branches, and it's also divided into colour-coded regions, with labels "acquire," "hold" or "grow," indicating the bank's strategy in each area.

But while Mr.Wetmiller is looking to add more dots to the map, he is also wary of an intensely competitive environment that is eating into profits for everyone in TD Banknorth's home patch.

Large global players such as Citibank and HSBC, as well as regionals including Commerce Bank, are eyeing the same wealthy counties in Connecticut and other New England states as TD Banknorth.

"You are really seeing the big regional and national players come in to the market," says Brian Arsenault, head of investor relations at New Haven, Ct.-based NewAlliance bank, which has 71 branches in New England. "Just here in Connecticut we've seen Commerce Bank move in from New Jersey. Citi has expanded its presence, Chase has, HSBC has. These are banks that had no presence or a very small foothold."

Even in Portland, where TD Banknorth dominates -- the bank is No. 1 in deposit market share in Maine -- its sizeable head office is surrounded by buildings owned by Key Bank, Maine Bank and Trust and Bank of America.

But at least the big banks "play fair," says TD Banknorth's Mr. Wetmiller, noting that smaller competitors don't have shareholders to worry about or earnings targets to meet.

For example, a small bank that recently opened near a TD Banknorth branch in Burlington, Vt., is offering deposit rates that are well above the market. "We've been competitive in the Vermont area with a [deposit] offering of 4.75% for nine months, but right now to commemorate their new opening we're battling up against a 5.55 rate on the same terms with absolutely no hooks attached," says Mr. Wetmiller.

Competition is just as tough on the loans side of the business, with a noticeable tightening of competitive pressure even since TD bought into Banknorth in 2005, says John Fridlington, TD Banknorth's chief loan officer.

For large loans -- more than US$8-million -- TD Banknorth used to battle with three or four competitors, but now eight or more come "sniffing around," says Mr. Fridlington. On smaller loans, customers who would have negotiated with a single lender are now talking to three or four.

Not only does that mean it is harder to seal the deal -- the bank will likely try to win more loans than usual this year, but will probably end up with a lower rate of loan growth -- but typical rates are being driven down too, says Mr. Fridlington, by as much as 100 or 125 basis points. With smaller banks in particular also "pushing the envelope" on terms -- guarantees, fees and covenants -- "You need to have the pencil sharp and understand where your limits are," he says.

This month, TD Banknorth revealed that it is already feeling the heat from all that competition. The bank issued a profit warning stating expectations of third quarter 2006 earnings of about US58 cents a share were overly optimistic. The bank offered a downgraded outlook of US51 cents to US54 cents a share, "in light of current interest rates and the competitive environment."

Observers say the bank is also struggling with the cost of integrating and updating some of the branches it has recently acquired. TD Banknorth executives acknowledge that the Hudson United branches in particular reflect the fact the previous owners "consciously under-invested" in its branches.

"Some of [the existing locations] are tired old cavernous spaces with nothing in them except maybe a desk here or there," says Wendy Suehrstedt, president of the mid-Atlantic division of TD Banknorth.

In Montclair, N.J., for instance, another New York City commuter hotspot with a downtown crowded with dozens of banks, the TD Banknorth branch is tucked away on a corner location that doesn't get much pedestrian traffic. Inside, the decor is washed out and the branch manager sits at a desk in the middle of the room, with little privacy for customers who want to discuss their finances.

Still, TD Banknorth is pouring resources into supporting its new acquisitions. The Montclair branch, like dozens of others, is scheduled for an overhaul and will soon move from its tight 1,400 square foot unit to a spanking new 3,800 square foot location around the corner.

The bank has also got its hands on US$25-million from parent TD for a marketing campaign to promote the bank's brand. On the highways that circle commuter-land around New York City, billboards proclaim in TD green and black the new "Bank Freely" strategy, in which the bank is offering a no-fee ATM card to customers in some areas. It is aimed at providing the convenience of a much larger branch network for customers who, for instance, live in the commuter-belt but work in downtown Manhattan, where the bank has almost no presence.

Ms. Suehrstedt says the bank's own surveys show that TD Banknorth's brand recognition in some former Hudson United areas has gone from non-existent to 18% in just a couple of months, while the no-fee ATM card has helped the bank triple new account openings in some areas and has led to several copycat measures from other banks in the region.

It's all eating into profits in the short term but it shows the lengths TD Banknorth is prepared to go to get a bigger share of this wealthy part of the United States.

But while profits are hurting right now, TD chief executive Ed Clark has always preached a long-term view for the Banknorth investment. Indeed, the Canadian bank has shown its commitment to further growth, dispatching TD veteran Bharat Masrani to help run TD Banknorth, and freeing up chief executive Mr. Ryan to search for more targets.

In fact, the intensely competitive environment could be playing right into TD Banknorth's long-term growth strategy. Ultimately, if smaller competitors begin to struggle, that will mean there is more room for banks such as TD Banknorth to grow.

"[The smaller banks] are going to come under tremendous pressure," says Ridgefield's Mr. Smith, with the result they will likely seek the shelter of a merger. Although banks such as his own may be too small for a TD Banknorth to bother with just now, the more consolidation that takes place, the more acquisition targets are likely to appear. Mr. Smith predicts that in the next couple of years the number of banks in the U.S. could fall to perhaps 4,000 or 5,000 from about 9,000 today.

Mr. Ryan was unusually bearish on the opportunities for acquisitions this week. He said prices are worse now than even a few months ago with smaller U.S.-based banks holding out for a good deal.

"It's going to be difficult right now to buy banks at a price that makes sense," said Mr. Ryan. Many banks in the United States have a built-in premium in their stock price and are looking for something extra on top of that.

He knows that can't last forever.

"We do have cycles," he said, forecasting a possible turn in his favour in late 2007 or early 2008 when competitive pressures will finally start to take their toll.

When that happens, and with TD's deep pocket to back him, "we'll be aggressive," he says.