Friday, June 13, 2008

Will Banks Buy in the US?

Reuters, Lynne Olver, 13 June 208

Canada's big banks have weathered the credit crunch in relatively good shape and should swoop in to buy some ailing U.S. banks, observers say.

Royal Bank of Canada, the country's largest bank, and Bank of Montreal, the fifth largest by market value, are best positioned to make U.S. acquisitions, CIBC World Markets analyst Darko Mihelic said on Friday in a research note entitled "Fish or Cut Bait."

The banks have excess capital to use and relatively clean balance sheets, Mr. Mihelic noted.

"Perhaps now is the time to think big," he wrote.

U.S. banks have taken a beating, with the KBW Bank index down by more than 40% in the past year. Over the same period, the S&P/TSX banks index of large Canadian banks is down 17%.

Considered another way, the Canadian bank stocks trade at about 2.1 times book value, while the median of seven U.S. large-cap regional bank stocks is right at book value, according to RBC Capital Markets.

Eric Bushell, chief investment officer of Signature Advisors within Toronto-based CI Investments, told a conference this week that Canadian banks will come out of the credit crunch episode as bigger and more global players.

"The Canadian banks came into this situation extraordinarily well capitalized and have essentially twice the amount of return on weighted assets as the U.S. banks," Mr. Bushell said at a Toronto conference organized by research firm Morningstar.

"I think they're in a position to really pick over the carcasses," said Mr. Bushell, who runs the $4.2-billion CI Signature Select Canadian fund.

Dennis Gartman, the Virginia-based author of investment newsletter The Gartman Letter, said at the same conference that Canadian banks would be "in the driver's seat" for the next decade.

"They're going to come around buying everything in the United States ... they're in great condition."

Royal Bank of Canada, which acquired Alabama National Bancorp earlier this year for $1.6-billion, has ample targets and its stock carries a hefty premium multiple, CIBC analyst Mihelic said.

U.S. banks in the U.S. Southeast, where RBC operates, and in the Midwest, where BMO runs Harris Bank, have seen their premiums to core deposits plummet to single digits in the past year, while these two Canadian banks' premiums to core deposits have held in much better, at 15%, Mr. Mihelic wrote.

He crunched numbers on possible RBC acquisitions of Regions Financial, and BB&T, saying Regions would add slightly to Royal's earnings in 2009, while cost savings of 5% would have to be found in a BB&T buy to avoid diluting earnings.

Before Alabama National, RBC's biggest U.S. purchase was the $2.3-billion buy of Raleigh, North Carolina-based Centura Banks in 2001.

As for Bank of Montreal, it has made a string of small U.S. purchases in the last few years, but paid less than $300-million in each case.

Mihelic said buying Huntington Bancshares would add to BMO's earnings without any cost savings, while Associated Banc-Corp would be a better geographic fit but more difficult financially.

BMO's management has said it will continue to look at acquisitions, while RBC's top executive has expressed caution about making a big U.S. move.

"Either they have the fortitude to make a deal and the capability to execute a deal or they need to re-evaluate their respective U.S. strategies," Mr. Mihelic said in his report.

As for other big Canadian names, Toronto-Dominion Bank just swallowed New Jersey-based Commerce Bank, and Bank of Nova Scotia, which has a strong presence in Latin America, has so far stayed out of U.S. retail banking.

However, Scotiabank's CEO said in May that U.S. bank valuations were "intriguing."
Financial Post, Duncan Mavin, 13 June 2008

According to numerous reports, the best chance for Canada's banks to go on a spending spree in the U.S. is right now.

American bank stocks are beaten up, even more than Canadian shares. As well, the Canadian banks are armed with a supercharged loonie and anyone who has done any cross-border shopping in the past twelve months knows what a great boost to buying power that means.

The Canadian banks should "Fish or Cut Bait," said CIBC World Markets bank analyst Darko Mihelic. He's not the only one.

But surely there's more to this picture than meets the eye. While there are bargains to be had, the top executives of Canada's big banks didn't get where they are today by deviating too far from long term strategy, and that means acquisitions will have to fit the plans of the banks or they just won't happen.

Take a couple of recent cases. In April, Bank of Nova Scotia kicked tires at National City Corp., a struggling Cleveland lender. But that deal fell through, in part because Scotiabank which doesn't have a U.S. banking plan isn't going to start one by spending billions of dollars on a bank with a dodgy balance sheet.

Another case: Toronto-Dominion Bank's purchase of Commerce Bancorp — which closed in March and has been valued at US$7-billion — fits the bill much more neatly because TD already has a U.S. strategy and the Commerce footprint ties in nicely with TD's existing U.S. geography. There's also the fact both banks — TD and New Jersey-based Commerce — have a strong commitment to high-service levels, which should make for better integration.

No doubt Canada's top banks are looking closely at their U.S. counterparts. But they are unlikely to buy a bank south of the border just because its cheap, and the targets they are scouting are much more likely to be bolt-on acquisitions that complement existing plans.

The Wall Street Journal said Friday that Royal Bank of Canada was a possible bidder for Lehman Brothers, whose stock has fallen markedly because of concerns about its exposure to the credit crunch. An RBC spokesperson was quoted in the story refusing to talk about the speculation. But if RBC really is looking at Lehman — one of the world's biggest brokers — it would be quite a departure for the leading Canadian bank that has turned in record profits in recent years in large part by improving its domestic retail bank. Spending billions of dollars on an acquisition that would essentially be a switch in strategy would surely be a tough sell to shareholders.