06 March 2006

Scotiabank & TD Branch Out

Bank of Nova Scotia picks up mortgage firm; TD Bank Financial Group chooses car-financing company

Investment Executive, Rudy Mezzetta, 6 March 2006

Acquisitions last month by two of the Big Six banks suggest Canada’s financial services giants are increasingly willing to tread into uncharted lending territory in an effort to capture new business in the otherwise mature domestic market.

Bank of Nova Scotia said on Feb. 14 it will purchase the mortgage business of Toronto-based Maple Financial Group Inc. , including Maple Trust Co. Two days later, TD Bank Financial Group announced it will acquire VFC Inc. , a Toronto-based provider of car financing to higher-risk borrowers, as well as consumer loans. Both deals are pending regulatory approval.

“These are areas that the Canadian banks haven’t gone into before, but I would see them as reaching two different types of ultimate clients,” says Brenda Lum, managing director of the Canadian financial institutions group for Toronto-based Dominion Bond Rating Service Ltd. “Maple doesn’t necessarily focus in on the near-prime or subprime markets, as opposed to VFC, which does.”

Scotiabank’s $233-million deal to acquire Maple Financial makes it the country’s third-largest mortgage lender behind Royal Bank of Canada and CIBC. The acquisition also doubles Scotiabank’s originations through the mortgage broker channel. Maple Trust, which has $7.5 billion in mortgages under administration and more than 42,000 mortgages outstanding, has prospered by developing strong relationships with mortgage brokers. Maple Trust’s size in the mortgage market, however, is dwarfed by that of Scotiabank, which has $75 billion under administration and about 650,000 mortgages.

“The strong mortgage broker relationships are the key success factor for Maple Trust,” Lum says. “The acquisition is an additional vehicle for Scotiabank to generate originations.”

Lum adds that Scotiabank’s lower cost of funding would help Maple Trust’s profitability. The deal also includes $1 billion in deposits held by Maple Trust.

Although Maple Trust’s business would be termed “low-risk” lending, with 94% of its mortgages covered by default insurance, this acquisition opens the door for Scotiabank to begin to tap into the burgeoning below-prime market, something it has said it intends to do.

“We believe that the near-prime mortgage market represents a significant opportunity for Scotiabank’s retail lending business,” says Charles Lambert, managing director of mortgages for Scotiabank. “It is a growing business, estimated at more than $20 billion last year. Upwards of $1 billion of our [declined mortgages] last year could have qualified as near- or subprime.”

Scotiabank also says it believes the acquisition gives it a great opportunity to cross-sell its broad line of credit, insurance and other products to Maple Trust’s 42,000 customers, the majority of whom are based in Ontario, Alberta and British Columbia.

As part of the deal, Scotiabank says, it will absorb Maple Trust’s 200 employees, including its nine-member management team, who have been contracted to stay on for at least three years, and 45 mortgage development managers, who develop and maintain the relationships with mortgage brokers.

Meanwhile, TD intends to run VFC, for which it is offering an estimated $326 million in cash and stock, as a separate brand under VFC’s existing name and management structure. Its management team has also been contracted to stay on for three years. VFC’s board has unanimously approved the acquisition offer.

Under its TD Canada Trust division, TD already has an existing indirect car-financing business, but the purchase of VFC allows the bank to enter the near- and subprime financing market.

“What happens currently is those customers who wouldn’t necessary qualify under our quite strict prime-based lending guidelines are generally referred by the dealers directly to VFC,” explains Tim Hockey, group head of personal banking at TD and co-chair of TD Canada Trust. “We figure that by acquiring VFC, there’s quite an opportunity to cover a larger part of the car-financing space.”

VFC, with offices in Toronto, Montreal, and Nanaimo, B.C., has 220 employees handling $380 million in finance receivables, more than 25,000 customers and a network of 2,000 auto dealers across Canada. As with the Maple Trust acquisition by Scotiabank, the VFC deal offers TD the chance to acquire a strong business, provide lower-cost funding, and potentially cross-sell products to new customers. But the VFC deal also gives TD the opportunity to gain competency in the near- and subprime market.

“Near and subprime lending is a relatively small part of the market, but it is growing fast,” says Hockey. “It could be in the high teens or 20s in percentage of the market overall when it reaches maturity. So, the question facing us when we were considering entering this space is why we would want to excuse ourselves from that market.”

Says Lum: “This particular acquisition isn’t big, but what TD is doing is getting into the business with an experienced team. It’s small, and [TD is] going to learn from it.”

The big banks traditionally have avoided this market segment; although it is potentially lucrative because of higher lending rates, the segment carries the risk of defaults and of damage to a bank’s reputation. Hockey says TD considered those risks, among others, before it bought VFC, and was satisfied VFC was a good deal.

“I would put reputation risk worries down more to a lack of understanding, both by consumers at large as well as banks generally,” he says. “It stems from worries that an organization will have usurious rates and scare collection tactics, and that’s not the case. VFC is an extremely well-run organization that completely fits with the way we would conduct business.”

(Lending rates in non- and subprime lending can range from the low teens to more than 20%.)

Hockey says the financial models TD ran during the due diligence process before making this acquisition suggest that this deal is sound — even if a severe economic downturn occurs. The deal’s relatively small size mitigates the risk, as well.

“Even if we doubled VFC’s asset size in the next few years, it would still constitute less than 1% of our overall consumer lending assets in Canada,” Hockey says. “It’s a very small piece of business in the grand scheme of things.”