Wednesday, January 10, 2007

CIBC Seen Increasing Caribbean Presence

Dow Jones Newswires, Monica Gutschi, 10 January 2007

First Caribbean Bank, a majority-owned unit of Canadian Imperial Bank of Commerce, may purchase a stake in a Trinidadian bank as a precursor to a merger, BMO Capital Markets suggests.

In a report, analyst Ian de Verteuil said press reports out of the West Indies indicate First Caribbean is discussing a 14% stake in Royal Bank of Trinidad and Tobago, or RBTT, one of the largest banks in the region.

The move could set the stage for First Caribbean and RBTT to join forces and create a powerhouse in the region, de Verteuil said.

It would also come shortly after Canadian Imperial closed its purchase of 87% of First Caribbean for US$989 million and extended its offer to purchase all remaining outstanding shares.

"We believe that a second move in the Caribbean would highlight that CIBC is not too far behind its Canadian banking peers in developing non-Canadian platforms," de Verteuil said.

After some disastrous forays in the U.S., Canadian Imperial has mainly retreated to its domestic base. It surprised the market last year by increasing ownership of First Caribbean by purchasing the stake held by joint-venture partner Barclays PLC.

Now, de Verteuil said, it appears Canadian Imperial may take an even bigger bite in the Caribbean through RBTT. A merger of First Caribbean and RBTT - which are nearly equal in size - would create a diversified bank with footholds in several countries in the region, and drive a number of cost synergies.

"Together, the new entity would have a market capitalization of over US$4 billion and would be well diversified with strength in virtually all markets in the Caribbean. For perspective, in every one of the top five economies of the English-speaking Caribbean, a combined FCIB/RBTT would have a leading market share position," de Verteuil wrote.

Rob McLeod, a spokesman for Canadian Imperial, declined to comment.

De Verteuil noted that RBTT already has close historical ties to Canada, and in fact was at one time part of Royal Bank of Canada, which sold down its stake in the 1970s and 1980s. He said there have been rumors of a deal brewing between Royal Bank and RBTT. In that case, a solid stake in RBTT would put First Caribbean in a good position if there is a competitive bidding situation.

As for Bank of Nova Scotia, the Canadian bank most active in the Caribbean region, de Verteuil said it operates under a different structure than either First Caribbean or RBTT, making synergies less likely.

Rather, he said, Bank of Nova Scotia would probably be able to capitalize on any disruptions from the merger, and also likely look favorably on any divestitures that might arise. Overall, de Verteuil said, any impact on Bank of Nova Scotia would be minimal.

BMO Capital Markets, 09 January 2007

Caribbean Opportunity: One Hand Cyar Clap (West Indian saying that when translated means that 'It is best to operate in a spirit of co-operation.')

Background on RBTT

Canadian investors are unlikely to be knowledgeable on RBTT, but it has been a true Trinidadian success story. It is an excellent financial institution, with strong financials and a great reputation. We show the past five years of financials in Table 1. Clearly, the bank, which is audited by PricewaterhouseCoopers, has had a good track record of profitability. Unfortunately, in the past two years earnings growth has slowed, as the bank has had to deal with a weakening of the Jamaican dollar and an expansion out of its highly profitable Trinidad base. We note that as the bank uses IFRS accounting standards, there tends to be above average volatility in securities gains. Furthermore, we consider 'normal' loan losses to be in the US$25-35 million range annually. RBTT’s Tier 1 exceeds 12% currently.

Interestingly (and as noted in our detailed report on Caribbean Banking, 'Options in the Sun,' dated March 2006), RBTT actually has very close historical ties to Canada and operated for most of the past century as a part of Royal Bank of Canada. Throughout the 1970s and 1980s, RBC sold down its interest, and by 1985 the bank was entirely owned by locals, with the employees (through its pension plan) having a large ownership stake.

RBTT has strong positions in three of the five major economies of the English-speaking Caribbean: Trinidad, Jamaica and the Dutch Dependencies (which we include as part of the English Caribbean largely because they associate with this group of islands rather than the Spanish-speaking Caribbean islands). As we show in Table 2, RBTT’s deposit market share is strong in several of the large markets of the region.

Why Buy a Block of Stock When the Goal Is Probably an Outright Merger?

Some will be surprised by a decision by FCIB to buy a stake in RBTT if indeed the goal is a merger of equals. The answer is that it is the seller (Guardian Holdings) of this large block of RBTT shares appears to be motivated. We won’t deal with the specifics of the problems with Guardian Holdings, other than to say that the connection between RBTT and Guardian is long and convoluted. Both entities have gradually been severing the relationship and RBTT sold its stake in Guardian in 2005.

We believe that by purchasing this block of stock, FCIB ensures that it is well positioned in the event of a competitive bidding situation for RBTT given it, along with the employee pension plan, will be the largest shareholder. We should note that there have been well-reported rumours of a deal between Royal Bank of Canada and RBTT over the past 18 months. In the event of a hostile, high-priced bid, FCIB can sell the RBTT shares at a later date should it decide to do so. Furthermore, there are other strategic options for FCIB in the event that it and RBTT are unable to negotiate a reasonable exchange offer.

Why a Merger?

In our opinion, both entities are hamstrung and a merger would be a major step forward for shareholders of each entity. First, FCIB has built up an excellent business out of the merger of the Caribbean platforms of Barclay’s and CIBC, with a bent toward offshore activities. It has very strong market positions in Bahamas, Barbados and Cayman. It has attempted to tackle the two big local economies- Trinidad and Jamaica- but, so far, results have been modest. We doubt that it will make much headway if it proceeds with its gradual-build strategy.

On the other hand, RBTT is very strong in Trinidad and has had some success in Jamaica and the Dutch Antilles. It is primarily an onshore entity and has made some progress in wealth management and merchant banking (the latter, in Caribbean terms, describes anything involving capital markets, such as debt offerings, government and project funding, corporate banking, etc.). While the bank has been aggressively expanding outside of its home market, its non-Trinidad operations have not been tremendous profit contributors. We note that Trinidad has continued to produce over two-thirds of annual profits.

We believe that the combination of FCIB and RBTT would effectively be a better bank. In the short term, the merged entity will be better diversified, which should help credit ratings. In addition, we believe that there are potential cost synergies in Jamaica and the Dutch Antilles.

The more interesting story, however, is the long term. Together, the new entity would have a market capitalization of over US$4 billion and would be well diversified with strength in virtually all markets in the Caribbean. For perspective, in every one of the top five economies of the English-speaking Caribbean, a combined FCIB/RBTT would have a leading market share position (see Table 3 for pro forma market positions). Typically, the leading banks in the region are able to attract and retain the best talent.

How Would this Compare to Scotiabank?

No foreign bank has been as successful as Scotiabank in the Caribbean and we expect it to continue to be a leader in the region. The structure of Scotiabank’s operations in the Caribbean is quite different than that used by FCIB or RBTT currently. We describe Scotiabank as operating several 'local Scotiabanks' in a variety of countries.

Great examples include Scotiabank Jamaica (SBJ, which is 70% owned by BNS) and Scotiabank Trinidad and Tobago (SBTT, which is 51% owned). These entities are publicly listed on regional stock exchanges and the minority shareholders have been tremendous winners from the partnership with Scotiabank. There is no question that the largest shareholder is in control of the board or the management, but minority investors have won from leveraging the technology and infrastructure of a global entity such as BNS.

A great (and very obvious) example of this benefit to minority shareholders is evidenced by a simple visit to the website of all the Scotiabank subsidiaries in the Caribbean. They are eerily similar to that of the parent (particularly the investor relations portions of the sites) and they are the best we have seen among the financial institutions in the region. Clearly, there is leveraging of IT spending.

Outside of the two big publicly listed entities (SBJ and SBTT have market capitalizations of US$1.6 billion and US$460 million, respectively), Scotiabank has also operated in the Dutch Antilles through a 50/50 joint venture with Maduro and Curiel. This operation, like SBJ, has a dominant franchise in its home market and unusually high levels of profitability. We believe that Scotiabank subsidiaries in the Caribbean have been able to attract and retain some of the best and brightest executives from the region, with Scotiabank providing tremendous mobility and opportunities.

There would certainly be positives and negatives for Scotiabank from a combination of FCIB and RBTT. In aggregate though, we don’t believe that the impact would be material. First, Scotiabank will likely be able to capitalize in the short term on possible disruptions arising from integrations that would be necessary in Jamaica and the Dutch dependencies. In both markets, Scotiabank is the dominant bank.

Second, we would not be surprised if there were some divestitures required, particularly in Barbados, where FCIB is the leading bank. We believe that BNS (and, for that matter, Royal Bank) would be well positioned to acquire branch clusters. Longer term though, a merged FCIB/RBTT merger could become, as we have mentioned, the premier Caribbean-based financial institution. While its position would not be materially different than that of BNS in aggregate, the reality is that this new entity would be a single entity with a much higher earnings stream than any of the individual operating entities within the Scotiabank umbrella.

Why Wouldn’t Scotiabank Buy RBTT?

Given the geographic overlap, a Scotiabank-RBTT combination would have much more synergies than a FCIB-RBTT combination. We estimate that cost savings would be at least twice as large, with material cost-reduction opportunities in Trinidad and Tobago and the Dutch dependencies. Furthermore, Scotiabank has a broader and more developed management team and a longer track record.

Why then isn’t Scotiabank the most likely partner with RBTT? We believe there are two reasons for this. First, and as we have previously mentioned, it operates in many of these regions as separate publicly listed units. As such, RBTT’s operation would truly have to be split up to match Scotiabank’s current footprint. Otherwise, Scotiabank would be operating more than one large entity which would compete among one another.

Second, the degree of concentration would be significant. We have included a table of combined market shares across the six major markets. We note that market share would likely be concerning in three of the top markets- indeed in Jamaica and the Dutch dependencies, pro forma combined market shares would be well over 50%. We have often said that any Scotia 'banking' transaction in the region would involve more negotiations with local governments, rather than with selling shareholders given the degree of potential job losses and level of concentration. Readers may want to compare Tables 3 and 4 for the potential concentration issues.

Nevertheless, we can never count Scotiabank out in the region, and it would be in its best interest to try to play spoiler (or at least to raise the price). It has a long history and excellent relations with local regulators, and it could make extensive commitments to maintaining jobs, wholesale branch divestitures and local decision making. Despite this, we view a BNS-RBTT deal as a real long shot. If it were not, we believe they would have done this deal several years ago.

Economics of a Merged Entity

We have modelled a merger of RBTT and FCIB using a merger of equals approach (see Table 5). We have assumed a swap ratio that is consistent with the earnings of the two entities, and have used an 85%/15% equity to debt funding mix. This results in 'Newco’s' balance sheet becoming somewhat more leveraged- a Tier 1 of about 12% versus the current level of 15% for FCIB. Overall, though, it goes without saying that the new entity would remain very well capitalized, and the entity would have some backing from CIBC, which would own slightly over 50%.

A key assumption is clearly synergies- and on this front we have conservatively assumed that cost savings are limited to 25% of the non-T&T cost base. For purposes of simplicity, we have also ignored the impact of the 15% ownership stake that FCIB would have in RBTT, as this would likely be done on the same terms as a merger of equals.

We note that using this scenario, there would be EPS accretion of over 15%. As such, RBTT shareholders would continue to have ownership but the underlying entity would be better positioned and more profi table.

For CIBC shareholders, a deal of this type is slightly earnings accretive- about $0.08 per CM share. We note that this is a small impact for a Canadian bank that should earn over $8 in EPS in 2007. The impact on balance sheet is de minimus- the entity would continue to be fully consolidated and the swap of FCIB stock for RBTT stock would negate most of the impact on its Tier 1.

We believe that the deal would be quite positive from a strategic perspective for both FCIB and CIBC. CIBC continues to be perceived as a domestic retail bank with few opportunities beyond Canada (which, by the way, isn’t so disagreeable). We believe that a merger would allow CIBC to control a growth oriented leader in another region that would make up 8-10% of overall profits. This would be positive.

Having said this, we note that RBTT is not the only fish in the sea, and if RBTT is not willing to have its owners share in the benefits of a merger of equals, FCIB has other options in the region. We believe that any other alternatives for RBTT are likely to result in more 'foreign control' in the long term.