27 October 2007

RBC Rejects Ex-Trader's Claim on Bond Pricing

The Globe and Mail, Tara Perkins, 27 October 2007

Royal Bank of Canada, accused of ignoring complaints that traders were improperly valuing bonds, says it investigated matters within days and has found that its employees were not deliberately mispricing securities.

The complaints that it acted on came from Gregory O'Connor, a 44-year-old towering former college football player from California who had been working at the bank's office in Memphis for about three years.

Mr. O'Connor, who has spent his career in the bond business, alleged that some of his former colleagues were intentionally mismarking, or improperly valuing, government agency and corporate bonds in an effort to inflate profits in RBC's investment banking business.

In an interview yesterday, Mark Standish, the co-president of RBC's investment bank and head of global markets, said the bank carried out an investigation into its bond business, as well as its risk management practices, "and we concluded that there was nothing malicious involved here."

What happened, he said, is that some traders were slow to change the price, or value, of securities on their books as the market became much more volatile this summer. The bank took prompt action, he said.

"I'm not saying that losing a penny is not important, but the numbers are not material given the size of the business, and given what's happening in the marketplace," he added.

Mr. O'Connor was fired on Thursday, with the bank citing breach of its code of conduct. He gave an interview to The Wall Street Journal for a story that ran in yesterday's paper. The article noted that Mr. O'Connor had previously been in discussions with the bank about a severance package.

Mr. O'Connor had been the co-head of agency trading at RBC until February, when he was made a sales manager in RBC's Memphis office, overseeing a small team of about half a dozen sales staff.

In February, Mr. O'Connor called up the head of RBC's government agency trading desk in New York and raised questions about the price of a bond. "In February, I told them they had a problem, and they did not respond," Mr. O'Connor said in an interview yesterday.

Mr. Standish said RBC investigated and concluded that the bond was priced correctly.

In July, Mr. O'Connor sent an e-mail to Jonathan Hunter, head of RBC's fixed-income business, claiming that there were broader mismarks in the portfolio.

Mr. Hunter passed on the allegations, and, as a result, an official at the bank had an independent price verification done at mid-month that was more detailed than usual, Mr. Standish said. Further checks were then done.

"What we concluded is we did have a number of securities that the trader had been slow to update the marks on," Mr. Standish said. The end result was a markdown of about $8-million on the book, he added, but about $3-million of that was related to one bond issue that had just been launched at an "awful" time.

The bank said that, while it can be difficult to separate out trading losses from mismarks, losses in its government agency book were between $5-million and $8-million. In addition, losses in its corporate bond book were about $5-million.

The amount is not material for the bank, which reduced the size of its agency book by about two-thirds this summer to roughly half a billion dollars. "That's what you basically do when you get into periods of [market] turmoil," Mr. Standish said.

The bank also tightened up what's called "the aging process," which is how it moves inventory off its books. If inventory is sitting for a period of time, "you basically start charging that trader for having that position," Mr. Standish said. "You want to incentivize the trader to move it off the books."

As to the allegations, "I guess the question here is: Should the trading desk themselves have been more reactive, or pro-active, in terms of daily mark-to-markets. And the answer is, we've determined they were slow," Mr. Standish said.

Mr. O'Connor said in an interview yesterday that he sent an e-mail to Mr. Standish and Chuck Winograd, chief executive officer of RBC Dominion Securities, in mid-September, as he sensed that a number of job cuts were coming in RBC's sales force. The e-mail detailed his allegations of the "mismarking situation."

He said he sent that e-mail because people who had been mismarking bonds were still employed at the firm, while dozens of people in sales were going to be cut.

"I was looking for someone who would care," he said.
Dow Jones Newswires, 26 October 2007

The Royal Bank of Canada has rejected claims by a former bank trader alleging that some of his colleagues intentionally misstated the value of government and corporate bonds in an attempt to boost profits at the bank's New York-based investment-banking unit.

"These are meritless allegations," said RBC spokesman Kevin Foster in an email to The Associated Press on Friday. "His explanation for the existence of the small number of mismarkings is factually incorrect, and we acted immediately to address these issues."

The allegations were made by Tennessee-based trader Gregory O'Connor on Thursday, and were published in the Wall Street Journal's Friday edition.

The Journal had obtained emails that O'Connor sent to superiors at the bank alleging that other bankers were mismarking, or improperly valuing, bonds.

"Losses have been intentionally hidden over the last 5 months," O'Connor states in one e-mail, dated July 24.

Last month RBC, Canada's largest bank, recognized trading losses totaling US$40 million, of which US$13 million was related to bonds O'Connor alleges were mispriced, and fired several traders in its corporate-bond business.

The bank didn't acknowledge that the terminations were related to mismarking securities. O'Connor said in an interview that the fired traders' books were marked down to reflect losses after they left.

RBC also fired O'Connor on Thursday after the newspaper made inquiries, because, according to the bank, he violated the bank's code of conduct.

O'Connor, who worked in the bank's Memphis office, is seeking a severance package. His lawyer didn't immediately respond to calls for comment on the case.
The Globe and Mail, Tara Perkins, 25 October 2007

A former Tennessee-based trader at the Royal Bank of Canada is alleging that some of his colleagues were intentionally misstating the value of government and corporate bonds in an effort to boost profits in RBC's New York-based investment banking unit, the Wall Street Journal reports in its Friday edition.

Canada's biggest bank fired the trader -- who paints himself as a whistleblower -- on Thursday, after the newspaper made inquiries, the Journal alleges.

It obtained emails that Gregory O'Connor sent to superiors at the bank. He alleges in them that other bankers were mismarking, or improperly valuing, bonds.

In one, dated July 24, he said “Losses have been intentionally hidden over the last 5 months.”

In statement to the Journal, RBC said: “Mr. O'Connor knows full well that the firm took pains carefully to investigate the facts and took remedial action.”

“He is choosing to distort facts and damage the firm's reputation for his personal gain.”

Mr. O'Connor, who worked in the bank's Memphis office, is seeking a severance package, having been notified Thursday that he had violated Royal Bank policy by disclosing company information without approval, the article states. Mr. O'Connor spoke to the paper in an interview, as did his lawyer, who said Mr. O'Connor was “trying to do the right thing.”

As far back as February, Mr. O'Connor says he alerted a banker in charge of RBC's government agency trading desk that certain government bonds were mispriced.

He tracked a series of government agency bonds owned by RBC, and found that a number of bonds were actually cheaper than the prices traders had given them on RBC's books, he alleges.

Last month, the Royal Bank recognized $13-million of trading losses relating to the bonds that Mr. O'Connor alleges were mispriced, and the bank fired several traders in its corporate bond business -- though it didn't acknowledge that the firings were related to any alleged mismarking of securities -- the Journal reports.

Mr. O'Connor told the newspaper that the fired traders' books were revalued, or marked down, to reflect losses after they left the bank.

While the financial world is increasingly skeptical about the street's ability to accurately price mortgage-related securities, the issue is not associated with that type of investment, the article says, implying that this is an instance involving plain-vanilla corporate and government bonds.

While the bonds' values are fairly easy to determine, traders might have an incentive to boost their prices because it could have an impact on their bonuses.

25 October 2007

Highlights of RBC Analyst' Meeting with Banks

RBC Capital Markets, 24 October 2007


We recently met with executives at each of the Big 6 Canadian banks.

The key takeaways from the meetings were:

• The liquidity and credit crisis may cause near-term pain but it should also create opportunities.

• Retail businesses continue to grow; credit appears fine for now.

• There are more opportunities to deploy capital outside of Canada than domestically.

We have a positive 12-month outlook for banks based on their growing and highly profitable retail businesses, and on our expectations for a relatively solid Canadian economy, but we are still cautious in the near term. World financials are at risk of negative surprises and we believe capital markets earnings will decline in the next 12 months. The health of the economy represents a bigger risk to bank earnings and valuation multiples than the health of capital markets; if capital markets issues become economic issues, credit losses could rise much higher.
Financial Post, David Pett, 25 October 2007

If its recent bid to acquire US-based Commerce Bancorp pans out as expected, The Toronto-Dominion Bank may have a tough time keeping pace with its Canadian peers in providing shareholder value, according to Blackmont analyst Brad Smith.

"The magnitude of capital required to gain traction in the mature US banking market, which (including Commerce Bancorp) accounts for 66% of TD pro forma common equity, is likely to limit TD's ability to keep pace with the future dividend growth and share buybacks of its domestic peer banks," the analyst said in a note to clients.

He also said the strategic benefits of TD's US$8.5-billion for Commerce Bancorp, including scale, efficiency and access to a huge deposit base, are offset by some potential risks such as declining core banking profitability, overreliance on yield curve arbitrage and over-sized U.S. real estate exposure.

Mr. Smith maintained his "hold" rating and left his $77 price target unchanged.
The Globe and Mail, Tara Perkins, 25 October 2007

The head of Canadian banking at the country's biggest financial institution is bullish about the economy here, despite the turmoil that continues to rumble through the U.S. market and the banks there.

"[Canada's] economy is good, and the mortgage business is good," Jim Westlake told reporters during a lengthy discussion yesterday at the top of Royal Bank of Canada's tower in downtown Toronto.

He gave little indication that he is fretting over any collateral damage from troubles in the United States, but acknowledged that certain geographic pockets and certain businesses are suffering.

"I was talking to a client in Atlantic Canada last night who has a business that heavily supplies into the U.S. housing market," Mr. Westlake said. "Well, [they're] not having a good month."

But over all, he said, the bank is encouraged by the resiliency it has seen among Canadian companies.

"I think if you'd asked us two or three years ago: 'How do you think Canadian companies in Canada would fare at a 90-cent dollar?' I think we would have been more negative than what we are today" when the dollar's above par with U.S. currency, he said.

While the strong loonie makes headlines for hammering Canada's export industry, many people forget it also has some benefits, Mr. Westlake said. "Our businesses actually buy a lot of goods as inputs that are lower priced today."

Even the dramatic fallout from the U.S. mortgage market isn't getting the RBC executive down. "If the U.S. economy settles down and they get the types of growth that are forecasted right now, and you don't see any more secondary effect, we think it's not going to have any huge consequences" here, he said.

"If it doesn't get any worse than it is, we don't think it will have much of a significant impact at the retail level in Canada."

Mr. Westlake suggested RBC is not making any significant changes to its conditions for handing out loans to consumers and businesses. In fact, tighter credit conditions were a topic of general discussion a few years back, he said, adding he's glad RBC didn't make dramatic moves.

"We've been in such a prolonged period of benign credit that it's quite remarkable, and there were people suggesting that two or three years ago and we're glad we didn't stop doing anything two or three years ago."

The margins that banks earn on products based on the prime interest rate are being squeezed somewhat, Mr. Westlake said, noting "it's still a good market."
Bloomberg, Doug Alexander, 24 October 2007

Royal Bank of Canada, the country's largest lender, may become the second Canadian bank to open on Sundays to win more customers, said James Westlake, head of domestic consumer banking.

``We think it's a fairly limited number of branches and it probably would be in certain cultural markets that Sundays would seem to have a better fit,'' Westlake told reporters today during a lunch meeting at the bank's Toronto office.

Canadian Imperial Bank of Commerce, the country's fifth- biggest bank, next month plans to become the first Canadian lender to offer full-service banking on Sundays starting with six of its branches. Royal Bank has talked about Sunday hours ``for some time'' though Westlake said he hasn't seen any ``great demand'' for opening on that day.

Royal Bank added 40 new branches in Canada this year and aims to add 65 to 70 branches next year. About 50 of the new branches are near Toronto, Canada's most populous city. Royal Bank had 1,132 branches across Canada as of July 31, according to corporate filings.

Royal Bank has also attracted more than C$3 billion ($3.1 billion) in deposits to its high-interest savings account for Internet customers since it was launched in May, Westlake said. Half of those deposits are from new customers. The bank has more than 3 million Internet banking clients, Westlake said.
Financial Post, Duncan Mavin, 24 October 2007

With Merrill Lynch & Co. the latest in a procession of big U.S. banks to record massive write-downs related to the global credit crunch — losses in Merrill’s global fixed income business totaled US$7.9-billion — Canada’s domestic banks could be feeling a little more conservative than they were a few months ago, says Blackmont Capital analyst Brad Smith.

Canada’s banking year end is just around the corner (the banks’ financial years end on October 31) and they are likely to adopt a more cautious approach to valuations, Mr.Smith says.

Based on his calculations, Canadian Imperial Bank of Commerce has the largest exposure to collateralized debt obligations (CDOs) — the same sort of of investments that have led to the losses at some U.S. Banks.

“We continue to believe the risk of larger than expected CDO loss emergence to be above average at CIBC at domestic banks,” Mr.Smith says.

22 October 2007

RBC Sells Covered Bonds

Bloomberg, Steve Rothwell, 22 October 2007

Royal Bank of Canada, the nation's largest bank, received 3.6 billion euros ($5.09 billion) of orders for its debut sale of covered bonds, according to a banker managing the sale.

The 2 billion-euro issue, the first by a Canadian financial institution, is backed by domestic residential mortgages. Covered bonds differ from asset-backed securities in that the collateral backing the debt remains with the issuer, which becomes liable for the notes if the assets aren't sufficient.

The lender, based in Toronto, sold the five-year debt at a yield premium of 10 basis points, or 0.1 percentage points more than the midswaps rate, a benchmark for corporate borrowing in Europe, according to the banker, who asked not to be identified because terms of the sale aren't published yet. The bond's price will be set tomorrow, the banker said.

Barclays Capital, BNP Paribas SA, Commerzbank AG and RBC Capital, Royal Bank's investment banking unit, managed the sale of the debt, according to a statement sent by RBC Capital.

Fitch Ratings will grade the bonds AAA, its top investment- grade ranking, according to an Oct. 11. report by the ratings firm.
The Cover, 2 October 2007

The Royal Bank of Canada’s (RBC) debut covered bond issue is expected to closely follow existing UK structures when it is launched after a roadshow starting on Monday. RBC is hopeful that this familiarity coupled with Canada’s stable housing market will prove appealing to investors.

As Canada has no covered bond legislation RBC’s issue will take the form of a structured covered bond modeled on the UK framework.

“The RBC structure will be based on existing UK structures,” said David Power, vice president, market strategy and execution at RBC. “The Canadian legal system is similar to the UK legal system.”

RBC will be the issuer, while a limited partnership will guarantee the note and grant security of the cover pool assets in favour of noteholders.

One anticipated difference to the UK is that the valuation of the cover pool will be at market prices rather than book rates.

Unlike some highly rated issuers of structured covered bonds, such as HBOS, RBC, which is rated Aaa/AA-/AA/AA will not use a prematurity test on its covered bonds. The alternative option is having an extendible maturity, although this has previously been used mainly by lower rated issuers.

The Canadian deal is expected to closely follow the Capital Requirements Directive, enhancing its familiarity to the market.

The decision to follow the UK model was broadly welcomed by analysts, who considered it a prudent move given Canada’s similarity to UK law. “It was a good decision to follow the UK model, rather than the US,” said Ted Packmohr, a research analyst at Dresdner Kleinwort in Frankfurt.

Following the US structure would also have required additional regulatory approval, suggested one covered bond specialist, delaying the bond’s launch.

Packmohr did, however, have reservations about RBC’s timing. “Purely structured bonds have been sidetracked in favour of legislation-based covered bonds,” he said. “A thorough preparation of their market debut will thus be pivotal to RBC’s success.”

However, Power was confident that Canada will prove attractive to investors. “The Canadian mortgage market has several advantages over the UK mortgage market,” he said.

He cited the lower rate of 90 day mortgage delinquencies, at only 0.25% in Canada against 1.06% in the UK.

He also noted the lower economy-wide rate of household debt as a percentage of annual disposable income, which stands at 124% in Canada compared to 164% in the UK.

21 October 2007

RBC Leads Equity Underwriting in 2007

Globe and Mail, Boyd Erman, 21 October 2007

A shift in focus to smaller deals during the tumultuous third quarter helped the country's biggest investment bank, RBC Dominion Securities Inc., climb to the top of the rankings for leading stock sales so far this year.

RBC, after running 12 sales in the quarter, has led 40 deals this year in which companies sold $3.66-billion of stock to investors.

BMO Nesbitt Burns Inc. moved into second place with $3.37-billion sold in 31 deals, while independent shop Canaccord Capital Inc. showed its success early in the year is no fluke, claiming third spot by raising $3.31-billion in a whopping 80 deals. That's almost twice Canaccord's nearest competitor's total for transactions.

TD Securities Inc., which was the leader through the first two quarters, dropped to fourth spot.

After the mega-sales for stolid utility companies that characterized the early part of the year, the third quarter was all about leading deals for smaller, riskier plays in sectors such as resources, technology and real estate.

RBC, long known as a shop with its sights on big game, has capitalized by also winning smaller mandates. The firm didn't lead any of the five biggest deals in the quarter, which stretches from July 1 to Sept. 30.

“We're looking to identify and build relationships with attractive smaller-capitalization companies that are good candidates for growth,” said Kirby Gavelin, head of RBC's equity capital markets division.

So far, the final quarter of the year has started strong after the relatively quiet summer, a traditionally muted time of year when financings were even more scarce because of the turmoil in markets.

The focus on smaller, risky plays may continue into the fourth quarter, with cash still plentiful and investors looking for ways to bet on big themes that are driving markets, said Matt Gaasenbeek, head of North American capital markets at the firm.

“What we're trying to do is pick a few very large macro themes,” Mr. Gaasenbeek said. “One is the basic materials trade, and as part of that there's also the sustainability side as resources become scarcer. Another we are really focused on is the aging demographic, which plays into things like medical technology.”

TD Bank Leads Equity Underwriting in the 1st Half of 2007

19 October 2007

Scotiabank Investor Day

RBC Capital Markets, 19 October 2007

We expect management will continue to balance organic growth with acquisitions.

• International Banking's contribution to earnings grew from 27% in 2004 to 30% in 2006 (in spite of the stronger Canadian dollar, which appreciated 30% since the beginning of 2004) with 75% of the growth coming from organic initiatives. We estimate the contribution to earnings will grow to 34% in 2008E.

• Scotiabank has been successful in balancing local strategies with bank-wide resources. Management teams in each country focus on growing their business organically by implementing unique local strategies. The bank has also been able to leverage its presence in multiple markets via shared services and practices.

• From a distribution perspective, the bank adapts its strategies to local needs. For example, (1) 50 branches were built in Mexico last year and management expects 85 will be open this year with another 100 branches in each of the next few years for a total of 800+ branches by 2010. (2) In Peru, Scotiabank partnered with twenty retailers for 778 in-store locations, and is using low-cost correspondent tellers in high-traffic stores. (3) In the Dominican Republic, adding scale through branches is not required to maintain its top three market share position, so the bank is focused on reaching more clients through remote channels such as external sales forces, contact centres and the Internet.

• From a customer segmentation perspective, Mexico's management is targeting a consumer finance segment that will be new for the bank in Mexico but has the potential to reach 52 million people or 49% of the country's population. To start, it is launching a new low-limit credit card business via a 50/50 joint venture formed with a team of industry professionals to target this segment. Leveraging the expertise of the recently acquired bank in Peru will also help in the introduction of this new product in Mexico. In Peru, management sees opportunities in the Micro business segment with over 600,000 businesses to target its growth efforts. In the Bahamas, the bank hopes to target new segments such as small business, non-resident mortgages and wealth management.

• Each management team is also working with teams from other countries while implementing their own unique initiatives. Over thirty cross-platform teams have been organized to help and to learn from each other in their efforts. They implement best-of-breed ideas and share in global resources such as sales management systems, risk management processes and contact centres.

• The division should also benefit from acquisitions that were completed in the past few years and all successfully integrated within twelve months of the closing date. Since 2004, Scotiabank has spent $1.3 billion on acquisitions with another $1 billion committed for the announced purchase of Banco del Desarrollo in Chile. These acquisitions have provided good returns (for example, in Peru, the bank invested US$330 million at the beginning of 2006, and has earned US$86 million from January to July 2007), and at least doubled the bank's loan market share in Peru, Costa Rica, Dominican Republic, El Salvador and Chile. Through both branch builds and acquisitions, Scotiabank has grown its number of branches from 773 at Q4/04 to 1,154 at Q3/07.

• The bank is also making equity investments in banks that may grow, such as the 10% stake in FirstBank in Puerto Rico. Management also stated that it plans to increase the 25% ownership of Thanachart Bank in Thailand to 49% when legislation permits, which could be as early as next year.

• We believe management will continue to look for opportunities to deploy the bank's excess capital via acquisitions and investments, with a preference for targets in Latin America and the Caribbean, followed by Canada and Asia. Acquisitions in Central America are likely to be first on the bank's radar screen, as it views the region as less competitive given that it is too small to attract major international players.

Loan and deposit growth should continue to be faster than in Canada

• The International Banking segment has 5.2 million customers with 30% in both Mexico and the Caribbean. To grow, management is increasing its focus on new customer segments, channels and products within each country.

• Scotiabank intends to expand beyond its traditional mid market and commercial and corporate focus, by targeting three new client segments to help it reach its organic growth objectives: 1) Small Business, which has approximately two million prospects in Latin America; 2) Affluent, with over one million target households in its markets with over $250,000 in assets; 3) Consumer Finance, which management believes has over fifty million potential customers in Mexico alone.

• Scotiabank's management is focused on "earning their way through investments and acquisitions", with a focus on positive operating leverage. Leveraging the bank's shared services (such as contact centre activities, a new global Internet platform or its one data centre in the Caribbean) and operational support (such as the new sales management and finance MIS systems) is allowing the bank to realize scale economies.

• Loan growth has been strong at 11% CAGR from 2004 to 2006. We expect the rapid growth to continue based on rapid GDP growth, credit card growth and cross-sells of new products. Deposits have only grown at 4% CAGR during the same period, but we expect the rate of growth will increase as the bank is putting greater emphasis on the business. To further grow wealth management revenues, the bank has launched new mutual funds and is expanding its private client offering.

• We believe loan losses will rise as loan growth has been very strong and seasoning of recent growth should lead to higher losses. Retail loan delinquencies have been at cyclically low levels, and we are seeing a rise in the PCL ratio which grew from 1.0% at Q4/06 to 1.25% at Q3/07. Some businesses (in Peru for example) target higher-risk customers, and we expect growth efforts in certain business, such as credit cards and consumer finance, will lead to increased delinquencies and losses.

The macro environment in Scotiabank's International Banking footprint is favourable.

Emerging markets are healthier than the past. Fundamentals in key Latin American countries (Brazil, Chile, Colombia, Mexico and Peru) are in much better shape than the past. The improvement has been due to both cyclical and structural factors. The changes have allowed Latin American countries see ratings upgrades and rising stock markets (Exhibit 1), and the outlook for growth continue to look favourable.

Structural: Many Latin American countries undertook significant and painful reforms during the 1990s and the first half of this decade in the areas of fiscal/tax reform, banking reform (which has included opening up the banking system to foreign ownership, forced consolidation of banking systems that were fragmented, privatization of state-owned banks, etc.), energy reforms, labour reforms and political reform. These reforms have taken several years to fully implement and become entrenched into their economic systems. Latin countries over the past 5 years have begun to see the fruits of this painful labour as their economies have seen fiscal deficits dramatically shrink, banking system risk significantly reduced, and overall productivity and growth potential improve materially. Poverty levels have declined, and Scotiabank management estimates that by 2010, the majority of people in Latin America will join the working middle class. Today, the bank is adding almost 100,000 customers each month and the majority of them use only one service, so the opportunities for growth exist as the classes change.

Cyclical: There are a number of external forces which have been working together to bolster the performance of key Latin American countries. These forces are tied into the global business cycle including global growth, liquidity and commodities. The global economy has been growing at faster than a 5% pace for the past 3 years and is on track for another strong increase this year, stringing together the strongest run since the 1970s. Commodity prices have been rising well above historical averages and hitting all-time highs in some cases. This is particularly beneficial for Latin America given that many countries are commodity exporters. China and India's continued strong growth has been particularly beneficial given their large needs for commodities.

Latin American countries have in many cases undertaken deep and painful reforms to set their economies on the right track to ensure more stability and higher growth (including Brazil, Chile, Mexico and Peru). As a result, risk premiums have fallen dramatically for these countries as reflected in their sovereign debt spreads. The EMBI+ spread in Latin America has fallen to 180 bps from 1400 bps in a little over 5 years. In 1998, the spread was 400 bps before jumping to 1500 bps and then remaining within 600 and 1000 bps from 1999 to 2001 (Exhibit 2). Given the dramatic changes that have taken place in key countries where Scotiabank operates in Latin America, we believe the discount rate applied to cashflow from Scotiabank's Latin American operations should be reduced in line with other measures of risk premia such as the sovereign debt spread (mentioned above). This explains why we are not valuing Scotiabank's international business at a discount to its Canadian business anymore.


Our 12-month price target of $55 is a combination of our sum of the parts and price to book methodologies. It implies an approximate forward multiple of 11.9x earnings, compared to the 5-year average forward multiple of 12.5x. Our P/B target of 2.7x in 12 months is slightly higher than our target average for the banks given a higher ROE and strong capitalization. Our sum of the parts target of 12.1x 2008E earnings is in line with our target average for the banks, as strong performance in the growing international division is offset by greater exposure to business lending and the rising Canadian dollar, while the domestic franchise lags the two leading banks', in our view.

Price Target Impediment

Risks to our price target include the health of the overall economy, sustained deterioration in the capital markets environment, the potential for non-accretive acquisitions and/or related execution risk, deterioration in the Latin American political and economic climate, a rising Canadian dollar and rising business loan losses.

Company Description

Scotiabank is Canada's most international bank and most active corporate lender. Notable for a long track record as the low-cost Canadian producer, Scotiabank currently ranks third by market cap and second by assets. Scotiabank operates 988 Canadian branches and 98 wealth management offices, as well as 1,154 branches and offices internationally. The domestic bank contributes about 40% to earnings, while international banking and wholesale banking each add around 30%.
TD Securities, 19 October 2007


On October 16-17, Scotiabank hosted an investor conference in Lima, Peru highlighting its international platform. We had the opportunity to meet with a large contingent of Scotiabank executives, business heads and line employees that were in attendance.


Overall, the event served to reinforce our constructive view on Scotiabank’s international platform based on 1) the prospect of higher growth and returns in a number of countries and 2) Scotiabank’s demonstrated ability to effectively deploy capital in these markets.

We are not making any changes to our estimates at this point, although the presentations provided helpful detail on some key segments and identified organic growth and acquisition initiatives going forward. All told, we continue to expect their international business to deliver superior growth over the medium-term.

Investment Conclusion

We continue to highlight Scotiabank as one of the best outlooks in the group with what we expect will be a strong growth driver in International and signs of improving domestic progress.


We note the following highlights from the conference:

Management. Over the two days, we had the opportunity to meet with nearly two dozen Scotiabank executives, business managers and front-line personal. We were struck by the range and depth of experience across the team from a number of markets. Importantly, Scotiabank has had very good success in retaining top employees through acquisitions and attracting talent from competitors which speaks to their reputation in the market. We came away with comfort that Scotiabank has very capable talent to compete in the region.

Macro environment. We met with a number of economists and individuals with deep experience and understanding of LatAm’s political and economic development. Among them, there was a consensus that the region has made important structural progress. A number of countries now have more stable and diverse economies and a more effective political climate. This progress is reflected from 5-6 years of strong economic growth for the region, greatly reduced inflation rates and improved fiscal order with a number of countries moving toward or through investment grade ratings. There is still a tremendous amount of work to be done (for example, many of the countries have vastly under developed infrastructure), but overall we were encouraged by the outlook.

M&A prospects. Acquisitions in the Personal & Commercial space remain a key focus for Scotiabank in LatAm. In particular, we believe they would like to gain further scale in Chile, and a handful of countries in Central America. We also believe Scotiabank would like to enter Brazil in a material way, but the potential targets are larger and currently richly priced. In addition, the bank continues to look for a number of small niche opportunities that could compliment their existing retail banking presence.

We expect Scotiabank to continue making opportunistic moves in Asia, but do not expect the region to be a major driver of the investment case in the foreseeable future.

Integration success. Members of the bank’s M&A team and key participants in recent deals highlighted Scotiabank’s rigorous approach to due diligence and integration. With five meaningful deals successfully completed in the region over the past three years, the team is getting better and faster. Their track record and experience lends credibility to the acquisition strategy for the region in our view.

Organic growth. The platform should continue to offer superior organic prospects given the outlook for strong economic growth (nearly twice that of North America), the opportunity to increase penetration of banking services, and Scotiabank’s intention of continuing to consolidate market share.

Consumer finance. A number of growth initiatives were highlighted, but the most important was Scotiabank’s plan to expand into consumer finance. This market involves making small loans to consumers to finance purchases of things like appliances, furnishings or even clothing. We were given a tour of some of the in-store kiosks where customers apply for the loans and discussed at length the process and controls around managing credit risks: 1) they have 10 years of experience in this business in Peru 2) they apply a very fine filter (ie approximately 50% of applicants are rejected) using credit bureau reports, their own databases and in some cases personal home visits for verification 3) they use a graduated approach, extending very small loans with very short-terms initially 4) most importantly, they have wide flexibility in setting rates and as a result enjoy very strong returns (they suggest 15% ROA!).

They are currently building out this initiative in Peru, but expect to migrate to other regions (particularly Mexico) as they develop the business; targeting a market of over 70 million people.

Challenges. The event reinforced some important positives, but there are challenges. First, while greatly improved, the economies are still emerging and many of the larger ones remain tilted toward exports and commodities; clearly at risk should the current strength of global demand fade. Second, the distribution of improving conditions remain uneven and a source of potential social unrest. Finally, competition remains intense not only in day-to-day operations, but also in acquiring good assets at good prices.

Valuation and Justification of Target Price = $61.00

We expect Scotiabank to hold its premium valuation relative to the Big-Five banks, reflecting superior growth prospects, strong return on equity and healthy excess capital.

We base our target price on 12.75x forward earnings, a premium to our outlook for the group.

Key Risks to Target Price

The following are key risks that we have identified for Scotiabank and could prevent the stock from attaining our target price. These include: 1) the continued weakening of the U.S. dollar 2) country and political risk in its international markets such as Mexico 3) integration challenges associated with its recent and future acquisitions and 4) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

18 October 2007

BMO May Have Repurchased $13 Billion of Its Own ABCP

Financial Post, Duncan Mavin, 18 October 2007

Bank of Montreal may have raised as much as $22-billion in August to fund a massive buyback of its own asset-backed commercial paper, said CIBC World Markets analyst Darko Mihelic.

The bank may have repurchased $13-billion of its own ABCP with the funds in August and now has a significant amount of liquid assets available if further purchases in the troubled ABCP market are necessary, he said.

"It likely proved to be a wise 'bet' as liquidity further dried in September system-wide. We wonder what other banks may have to do in what we believe was a tighter market in September [for ABCP]," Mr. Mihelic said in a research note.

Asset-backed commercial paper is a type of security backed by a package of debt obligations, such as credit card debt or other loans.

A portion of Canada's ABCP market, known as non-banksponsored ABCP, worth $40-billion was hit by fallout from the U.S. subprime-mortgage crisis in August, leaving investors holding billions worth of commercial paper they could not redeem. While a team of investors, bankers and lawyers is working to thaw the non-bank ABCP market, there have been fears the problems could spill over into the banksponsored paper.

Mr. Mihelic said his analysis may show BMO raised funds by borrowing from other banks and by attracting commercial deposits, possibly in anticipation of problems in the ABCP market.

"BMO may have been ahead of the curve and prudent with respect to funding," he said.

Meanwhile, the CIBC analyst said the huge increase in assets is not likely to add significantly to fourth-quarter earnings at BMO, which has had a difficult year.

The bank's domestic retail franchise, which lags competitors, is struggling to make any headway despite some recent initiatives, while its U.S. Harrisbank network has produced "sub par results" despite a string of recent acquisitions, noted Mr. Mihelic.

New chief executive Bill Downe has also had to deal with 1,000 job layoffs as part of a $135-million restructuring, as well as a natural-gas trading scandal that has so far cost the bank $424-million in after-tax losses.

Most recently, BMO has been dragged into the ABCP quagmire and has also been exposed as a significant player in the U.S. sector of the global credit crunch focused on structured investment vehicles or SIVs. The bank said this week it is not part of a group of top U.S. banks that has organized a US$80-billion fund to deal with the problems around SIVs, but said it is "following closely" developments regarding the proposed fund.

Facing a weak fourth quarter, BMO has some "strategic decisions" to make about whether to incur further writedowns this year, said Mr. Mihelic.

"We believe it is reasonable to expect that BMO attempts to remove some of the uncertainty clouding its outlook by taking aggressive writedowns in the fourth quarter of 2007, and perhaps engaging in another restructuring, or in the very least seriously review some of its business activities," he said.

Bank of Montreal declined to comment on the CIBC report.
The Globe and Mail, Tara Perkins, 17 October 2007

The Bank of Montreal could be facing a significant write-down this quarter, because it may have been buying back billions of dollars in bank-sponsored asset-backed commercial paper, an analyst said in a note Wednesday.

Canada's banking regulator, the Office of the Superintendent of Financial Institutions, recently released data on the banks' August balance sheets.

BMO's balance sheet appears to have increased by $22-billion, or six per cent, during the month, CIBC World Markets analyst Darko Mihelic wrote in the note to clients.

“Approximately $13-billion of the increase was in debt securities where we believe the bank repurchased some of its own bank-sponsored ABCP,” he wrote. It appears that BMO funded the assets with wholesale deposits from both other banks and corporate customers, he added.

Canada's big banks operate on a fiscal year that ends Oct. 31. That means BMO might have some strategic decisions to make for year-end, Mr. Mihelic wrote.

”We believe there is a possibility that BMO records significant writedowns in [the fourth quarter],” he said. He declined to estimate the size of any potential writedown.

“We expect BMO's stock price to lag shorter term creating a buying opportunity,” he said. The bank has had a number of issues recently, including hundreds of millions of dollars in losses from its natural gas trading operations, and struggles at its basic banking business in Canada.

“We believe it is reasonable to expect that BMO attempts to remove some of the uncertainty clouding its outlook by taking aggressive writedowns in Q4/07 and perhaps engaging in another restructuring or in the very least seriously review some of its business activities,” Mr. Mihelic wrote.

He made it clear that “there is no definitive proof that BMO repurchased significant amounts of ABCP. However, it seems logical to us that this is in fact what occurred given the rather large movement in ‘debt' securities in BMO's August balance sheet. In other words, it is possible that BMO provided liquidity support to $13 billion of asset-backed commercial paper,” he said.

The Bank of Montreal has been one of the biggest players in Canada's bank-sponsored asset-backed commercial paper market. Commercial paper markets around the world fell into trouble in August when liquidity dried up. The problem was particularly severe in Canada's ABCP market that is not sponsored by the banks – the so-called third-party market, which is now frozen – while the bank-sponsored market continued to function. Mr. Mihelic noted that the other bank whose balance sheet expanded significantly more than its peers during August is National Bank, which has already disclosed that it is buying back about $2-billion of ABCP.

11 October 2007

Preview of Life Insurance Cos Q3 2007 Earnings

RBC Capital Markets, 11 October 2007

The insurers report Q3/07 results between October 30th and November 8th. Macro environment mixed for lifecos in Q3/07

• North American and Japanese equity markets were up on a year-over-year basis, which benefits all lifecos, but Great-West least so. Japanese equity markets were down sequentially, which may have a negative impact on Manulife's Japanese variable annuity reserves.

• We expect currency translation to negatively impact the big 3 lifecos' earnings growth by 2% on average with Manulife being the most impacted (3% to 4%). The Canadian dollar strengthened against the US Dollar (+6.2%) and the Japanese Yen (+9.1%), but weakened against the Euro (-0.9%) and the British Pound (-1.5%) on a year-over-year basis. Similar to Q2/07, we expect currency translation to have a negative impact on book value growth in Q3/07. Industrial Alliance is not impacted by currency translation.

• There were no major credit losses we are aware of, which benefits Manulife and Sun Life the most since they have more exposure to lower quality classes of bonds.

• Canadian long-term interest rates were up QoQ and YoY on average (though end of period rates at Q3 had declined vs Q2), while US and Japanese rates were down sequentially and on a year-over-year basis on average. Lower long-term interest rates negatively impact all lifecos, but Industrial Alliance and Manulife most so. If Canadian interest rates remain at current levels, they should have a positive impact on H2/07 earnings, though lower rates in the US and Japan may offset any positive benefit that Manulife would get from higher interest rates in Canada.

We expect Great-West to lead the group with EPS growth of 19%. We believe that main drivers for YoY growth at Great-West are: (i) increased profitability from European operations; (ii) earnings contributions from 401(k) acquisitions made in H2/06 and decreased integration expenses related to those acquisitions; and (iii) earnings contributions from the Putnam acquisition which closed on August 3rd.

Sun Life (October 30)

• We expect Q3/07E core EPS of $0.98, below consensus of $1.00. Our EPS estimate represents growth of 5% versus Q3/06 and 2% sequentially.

• Positive variable annuity flows in Q3/07 would provide additional confidence to investors that wholesaler productivity improvements experienced in Q2/07 are sustainable. New products such as Sun Life’s SunDex Bonus Fixed annuity, which was launched at the end of July 2007, may have a positive impact on annuity flows in the quarter. Improving performance in the annuities division is important as it accounted for 75% of US earnings in 2006 (including fixed annuities and equity indexed annuities).

• The growth rate of the non-MFS related Value of New Business for the 12 months ending June 30, 2007 lagged the growth in individual insurance and health sales, which implies a change in product mix or a deterioration in margins. Price increases implemented in Q1/07 for US individual insurance may have a positive impact on margins in Q3/07.

• Sun Life is expected to recapture a large portion of the strain recognized in Q4/06 and Q1/07 in H2/07 due to the implementation of a funding structure in June 2007. We estimate that the recapture of strain may benefit H2/07 earnings by $80-$120 million (pre-tax).

• We expect currency fluctuations to negatively impact earnings by approximately 2% this quarter versus Q3/06 due to the Canadian dollar appreciating by 6.2% YoY versus the US dollar. Partially offsetting this would be the appreciation of the Pound (+1.5% YoY) versus the Canadian dollar. US operations account for 33% of total earnings and U.K. operations account for approximately 8% of total earnings.

• We expect currency translation to negatively impact Q3/07E book value per share by $1.09.

Great-West Life (October 31)

• We expect Q3/07E operating EPS of $0.63 above consensus of $0.61. Our EPS estimate represents growth of 19% versus Q3/06 and 3% sequentially.

• Great-West closed the Putnam transaction on August 3rd. We are expecting Putnam to contribute $24 million in net income or $0.03 in Q3/07.

• US financial services should benefit from favourable comparables due to (i) poor morbidity experience in Q3/06 that impacted earnings by approximately US$12 million and (ii) 401(k) related acquisitions made in H2/06. Management indicated Q3/07 should be the last quarter of integration expenses (US$5 million) related to the acquisition of the US Bank business.

• We expect the European division to continue to positively surprise investors, based on:

• the strengthening British pound against the Canadian dollar;

• life reinsurance operations that are in a position to gain market share from the larger players, as primary insurers look to diversify their counterparty exposures; and

• the shift of acquired investment portfolios that back payout annuities toward higher yielding securities.

• We expect currency translation to negatively impact Q3/07E earnings by approximately 1% to 2% this quarter versus Q3/06. Great-West’s US and Reinsurance earnings should be negatively impacted due to the strengthening of the Canadian dollar versus the US dollar (up 6.2% YoY). Partially offsetting this is our expectation of positive earnings translations from Great West’s European operations due to the strengthening of the Euro (up 0.9% YoY) and the British Pound (up 1.5% YoY) versus the Canadian dollar. US operations (including Reinsurance and excluding Putnam) account for approximately 32% earnings, while European operations account for approximately 18% of earnings.

• We expect currency translation to negatively impact Q3/07E book value per share by $0.50.

Manulife (November 6)

• We expect Q3/07E core EPS of $0.70, slightly below consensus of $0.71. Our EPS estimate represents growth of 10% versus Q2/06 and (1)% sequentially.

• We believe that Q3/07 Japanese variable annuity sales results may top Manulife's previous best quarter of US$1.05 billion (Q1/06). Manulife's shares should react positively to an improvement in Japanese variable annuity sales as sales had declined to approximately US$400 million per quarter since July 2006, when a key product was shelved for regulatory reasons.

• We are expecting a sizeable year-over-year increase in the Value of New Business (VNB) driven primarily by (i) improved variable annuity sales results in Japan; (ii) our expectation that insurance sales will continue to be strong following a 15% increase in sales in Q2/07 compared to Q2/06 and (iii) an easy comparable due to Manulife’s Q3/06 VNB of $384 million that was negatively impacted by the shelving of a key variable annuity product in Japan.

• Positive equity market returns and good credit conditions should benefit Manulife’s earnings from (i) surplus (ii) variable annuities in the US and Japan and (iii) its John Hancock Fixed Investment division.

• The strengthening Canadian dollar versus the US dollar (up 6.2% YoY) and the Japanese Yen (up 9.1% YoY) should translate into an earnings drag of approximately 3% to 4% compared to Q3/06 for Manulife. Manulife’s US operations account for 45% of earnings and its Japanese operations account for 8%.

• We expect currency translation to negatively impact Q3/07E book value per share by $0.89.

Industrial Alliance (November 7)

• We expect Q3/07E core EPS of $0.78, above consensus of $0.77. Our EPS estimate represents growth of 13% YoY versus Q3/06 and 1% sequentially.

• At a recent presentation, management indicated that individual insurance sales would increase in H2/07 versus H2/06 while strain from individual insurance sales would decrease in line with its guidance of 50% to 55%. If Industrial Alliance delivers these results, we believe its shares would react positively.

• In August, IAG reported it had approximately $200 million of non-bank issued asset backed commercial paper (ABCP) and that it transferred approximately 50% of its exposure to its general fund in order to protect investors invested in money market funds from any potential losses. We expect IAG to provide an update on any write-downs related to its ABCP when it reports its earnings.

Power Corporation (November 8)

• We expect Power Corporation to report Q3/07E EPS of $0.69, up 19% versus Q3/06. The increase in earnings is a result of our expectation that Power Financial’s Q3/07 earnings will increase 19% year over year (see below). Power Financial represents approximately 100% of Power Corporation’s Q3/07 estimated EPS since the remaining component “Other Assets” is expected to have a negative contribution to earnings in Q3/07.

Power Financial (November 8)

• We expect Great-West to report Q3/07E EPS of $0.63, up 19% versus Q3/06. The expected increase in Great-West’s earnings is driven by: (i) integration of announced acquisitions including Putnam; (ii) continued strong growth in Europe; and (iii) potential improvements in US healthcare. Great-West represents 75% of Power Financial’s Q3/07 estimated EPS.

• We expect IGM Financial to report Q3/07 EPS of $0.81, up 13% versus Q3/06. IGM Financial represents 23% of Power Financial’s Q3/07 estimated EPS.

• We expect Pargesa to report an increase in core earnings of approximately 40% in Q3/07 versus Q3/06. The expected increase in Pargesa’s earnings is driven by: (i) increased ownership in Lafarge, Pernod Ricard and Suez; and (ii) increased dividend payments at Total, Suez, and Lafarge. Pargesa represents 3% of Power Financial’s Q3/07 estimated EPS


IAG Our 12-month price target of $45 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 13.0x earnings, compared to the 5-year average forward multiple of 11.8x. Our P/B target of 2.1x in 12 months is at the low end of our target for lifecos given a lower expected ROE. Our target P/E multiple of 13.0x 2008E earnings is higher than the company’s 5-year average forward P/E, as we believe Industrial Alliance is well positioned to benefit from higher interest rates, has increased its geographic diversification and has limited exposure to deteriorating credit quality. Offsetting those positives are uncertain equity markets and increased competition in the Canadian individual insurance market. Our target multiple on embedded value of 1.4x is lower than for the other two domestic lifecos, reflecting the mature nature of the Canadian insurance industry.

GWO: Our 12-month price target of $40 is a combination of our P/E and price to book methodologies. It implies an approximate forward multiple of 13.9x earnings, compared to the 5-year average forward multiple of 13.4x. Our P/B target of 3.1x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average. Our target P/E multiple of 13.5x 2008E earnings is in line with the company’s 5-year average forward P/E to reflect potential benefits from recent acquisitions, a more accommodating currency and limited exposure to deteriorating credit quality. Offsetting those positives are uncertain equity markets and increased pressure on US healthcare earnings.

MFC: Our 12-month price target of $47 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 14.5x earnings, compared to the 5-year average forward multiple of 13.1x. Our P/B target of 2.9x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average. Our target P/E multiple of 14.5x 2008E earnings is above the company's 5-year average forward P/E to reflect potential benefits from higher interest rates, rapidly growing value of new business, and potential for upward EPS revisions as our expected earnings growth is below what the company has historically achieved and is targeting, partially offset by deteriorating credit quality, uncertain equity market performance and lack of benefits from transformational acquisitions. Our target multiple on embedded value of 2.0x is higher than for the other two Canadian lifecos, reflecting higher prospects for growth in value of new business, because of the company's positioning in Asia and the US

SLF: Our 12-month price target of $57 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 12.5x earnings, compared to the 5-year average forward multiple of 12.1x. Our P/B target of 2.1x in 12 months is at the low end of our target for lifecos given a lower expected ROE. Our target P/E multiple of 13.0x 2008E earnings is above the company's 5-year average forward P/E to reflect potential benefits from higher interest rates, partially offset by deteriorating credit quality, uncertain equity market performance and lack of benefits from transformational acquisitions. Our target multiple on embedded value of 1.6x reflects the mature nature of the Canadian insurance industry and superior growth prospects in Asia.

POW: Our 12-month target price of $43 is based on a 12-month target NAV of $50 target price and a discount to NAV of 15% which is the mid-point of the average discount to NAV over the past 17 years (14%) and the past 5 years (16%). The current discount to NAV is 14%. Our target NAV is based on a $45 price target for Power Financial.

PWF: Our 12-month target price of $45 is based on a target NAV of $49 and a discount to NAV of 9% which is slightly above the trailing 5-year average of 8% and below the trailing 16-year average of 13%. Our target NAV is based on (1) a target price of $40 for Great-West which implies an approximate forward multiple of 13.9x earnings, compared to the 5-year average forward multiple of 13.4x (2) a target price of $59 for IGM Financial which is based on a sum-of-the-parts NAV approach. We separately value: the mutual fund business; the non-mutual fund business; and IGM's 4.2% stake in Great-West Life.; (3) a price of C$113.13 for Pargesa which is in line with the current stock price.

TD Newcrest's Ratings & Target Prices for Banks

TD Newcrest new analyst's ratings and target prices:

• BMO is rated "hold," 12 month target price is $70.00

• CIBC is rated "buy," 12-month target price is $115.00

• National Bank is rated "buy," 12 month target price is $64.00

• RBC is rated "hold," 12-month target price is $60.00

• Scotiabank is rated "buy," 12-month target price is $61.00

05 October 2007

Bank Writedowns

The Globe and Mail, Eric Reguly, 5 October 2007

UBS is a sober Swiss banking giant that has had remarkably few blunders since it was formed 10 years ago from the merger of Union Bank of Switzerland and Credit Suisse. But even it got engulfed in the U.S. subprime mortgage mudslide. On Monday, the bank announced it would write down the value of its fixed-income assets by $3.4-billion (U.S.), creating the company's first quarterly loss in nine years, and eliminate 1,500 investment banking jobs. Among the casualties was investment banking chief Huw Jenkins.

UBS had company. On Wednesday, another conservatively managed biggie, Deutsche Bank, said it would take a $3.1-billion charge, half of it related to structured credit products and mortgage-backed securities. The charge will push its investment banking business into a third-quarter loss.

Seasoned bank investors shouldn't be shocked by the writedowns. In spite of their size, generally capable management, attentive regulatory oversight and sophisticated risk management, big banks are remarkably fragile beasts. This is especially true of big domestic banks with big international ambitions, like UBS.

UBS is a retail banking and wealth management powerhouse, with growing and relatively stable profits from those businesses. That's the good news. The bad news is that it's hard for UBS (or any other bank, like Royal Bank of Canada) to expand in those areas beyond their home market. HSBC is one of the few banks to have pulled it off.

But size is everything for banks. They have to find growth somewhere. Management egos demand it; so do shareholders who like some daring mixed with their dividends. So they expand their investment banking and trading businesses outside of the domestic market.

When it works, it works beautifully. UBS has made fortunes from its global investment banking business and now has twice as many employees outside of Switzerland as within. Then - kaboom! - along comes a financial catastrophe like the subprime mortgage meltdown or a credit crunch. Or a wrong bet on a commodity trade - Bank of Montreal took a recent beating on natural gas. Or cowboyish behaviour mixed with arrogance. CIBC comes to mind. A few years ago, it retreated from the United States after taking huge writeoffs in its investment banking business and testing the patience of the U.S. Department of Justice and the Securities and Exchange Commission.

In banking, the retail business is a high-multiple business. Investment banking is a lower-multiple business because of unsteady earnings and occasional blowups. When you lump high- and low-multiples businesses together, you get a blend best described as mediocre. That's why big retail banks with big investment banking operations can be frustrating investments.

The solution? There isn't one, really. UBS has been under some pressure to spin off its investment bank. There is no doubt it has run the numbers. So, probably, has every other retail bank with a good-sized investment banking arm. The idea looks fine on paper, because it would shield the retail bank from investment banking volatility, allowing it to trade at higher valuation multiples. Then nothing happens. Shorn of the investment bank, the retail bank wouldn't have a growth strategy. Shorn of the retail bank, the investment bank would lose the protection of the cautious and highly profitable retail bank.

The Canadian banks, notably RBC and Toronto-Dominion, seem to have found the near-perfect balance between retail banking, on one side, and investment banking and trading, on the other. The Canadian banks dominate the domestic retail market, to the point foreign competitors - with the exception of HSBC - can hardly be bothered opening a branch. The profits they make from the retail network are lavish. At the same time, they have strong domestic wholesale operations and haven't blown their brains out trying to compete in this market beyond Canada.

Canadian banks have been rewarded for the compelling mix of highly profitable retail banking, dividend growth and middling exposure to investment banking and trading. In the banking universe, their high price-to-earnings multiples stand out. The made-in-Canada formula allowed TD to buy New Jersey's Commerce Bancorp for $8.5-billion without breaking a sweat. TD's fat multiple came in handy; three quarters of the price is being paid in shares.

UBS and Deutsche Bank will survive the subprime market problems. In fact, UBS's share price bounced up after the writedown and the announcement of firings were made (raising suspicions the bank used the credit crunch as an excuse to launch a delayed house-cleaning exercise). They might thrive. Then get whacked again. For investors, that's the price to pay for growth stories.

Scotiabank's Hunting for Specialty Acquisitions

The Toronto Star, Rita Trichur, 5 October 2007

The Bank of Nova Scotia is hunting for more boutique-style acquisitions for its wholesale banking business to build on the success of its 2005 takeover of energy advisory firm Waterous & Co., says its chief executive officer.

Rick Waugh said Scotiabank is being "inquisitive" in specialty areas such as energy, mining and other types of advisory work.

"We're looking," Waugh said in an interview this week, adding Scotia Waterous has been a "huge success ... I wish we could do more of that."

Scotiabank, Canada's third-largest lender, has deliberately pursued that "niche" strategy in an effort to compete with its larger rivals. And, given the swift pace of mergers and acquisitions in Canada's oil patch in recent years, its approach appears to be paying off.

Since January of 2006, Scotia Waterous has advised on more than $25 billion in oil-and-gas assets and companies, including about $8.4 billion outside of North America.

Its biggest coup is arguably the advisory work it did for Canadian Natural Resources Ltd. on its $4.24 billion purchase of Anadarko Petroleum Corp.'s Canadian subsidiary last year.

While organic growth remains Scotiabank's first priority for its wholesale banking division, Scotia Capital, it continues to scout for other tuck-in acquisitions. "We'll also look because our balance sheet is strong, our liquidity is strong, our earnings are strong," Waugh said.

And based on some forecasts, the timing couldn't be better. Even as oil companies squabble over royalties, it is clear there is plenty of money to be made in the oil patch.

CIBC World Markets chief economist Jeff Rubin predicts that crude oil prices, currently trading around $80 (U.S.) a barrel, are likely to hit $100 a barrel by the end of next year. He forecasts OPEC's export capacity to fall, thereby raising the profile of the Canadian oil sands as "they represent anywhere from 50 to 70 per cent of the world's oil reserves open to private investment."

Scotiabank, however, is not the only Canadian bank that appears ready to do more shopping. With two big foreign takeover plays by Canadian banks just this week, analyst Shannon Cowherd of Citi Investment Research suggested yesterday that the Bank of Montreal is next in line to do a deal.

"Based on a hypothetical analysis we think TCF Financial would make the short list as a potential target for BMO," Cowherd wrote in a note to clients. TCF Financial is a Minnesota-based financial holding corporation with $15 billion in total assets, 446 offices in seven states and market capitalization of about $3.5 billion.

Tim Crane, president of BMO's U.S. subsidiary, Harris Bancorp, said last week the bank will be "aggressive" in its quest to expand in the U.S. midwest.
The Globe and Mail, Tara Perkins & Shirley Won, 5 October 2007

CI Financial Income Fund is putting the finishing touches on its hostile $3.2-billion bid for all of DundeeWealth Inc., but the Bank of Nova Scotia's chief executive officer appears confident his bank would win the wealth management firm, should it come up for grabs.

The bank has just closed a deal to buy 18 per cent of DundeeWealth.

"If they decide to sell, certainly we would [want to buy 100 per cent]," Scotiabank CEO Rick Waugh said in an interview. "We're good partners, and I'm pretty confident that if they decide to do that, we'll be able to do that."

Toronto's Goodman family, which controls DundeeWealth, says it has no plans to sell the rest of the company, so the working assumption is that a sale is not in the cards, Mr. Waugh said. Scotiabank has a right of first refusal if the company does come up for sale.

The Goodmans agreed to sell 18 per cent of DundeeWealth, which owns Dynamic Mutual Funds, to Scotiabank last month at $12.76 a share because it took the money-losing Dundee Bank off their hands. Scotiabank's $608-million deal closed last Friday.

But CI Financial CEO Bill Holland has been shaking things up with his $20.25 a share offer for all of DundeeWealth. The offer, first announced on Sept. 24, is a 52-per-cent premium to DundeeWealth's closing price that day. CI has said it would be in a position to mail its takeover bid in early October.

Mr. Waugh said he's not worried about potential rivals courting DundeeWealth, saying Scotiabank has the upper hand with its new, close relationship with the company.

He's assuming the Goodmans won't put the company on the auction block. "Meanwhile, we have 18 per cent with three people on the board, we can equity account so we don't have to even ask them for a dividend," Mr. Waugh said. "And, importantly, we have this white label bank."

"We're comfortable growing with them," Mr. Waugh added. "We get all these other benefits, and we still have our options open. It's classic win-win."

Mr. Holland declined yesterday to comment on Mr. Waugh's remarks or CI Financial's formal takeover offer. CI Financial's offer, which includes fully diluted shares, has increased because it now includes the new Scotiabank shares.

Elliott Soifer, an arbitrageur at Desjardins Securities Inc., said he is not surprised that Scotiabank would want to buy all of DundeeWealth.

"This would be extremely timely and strategic for Bank of Nova Scotia, because it catapults them into the big leagues [of fund companies]," said Mr. Soifer, whose firm became a DundeeWealth shareholder after CI announced its bid. "They would have bought the whole company if they had the chance the first time."

Mr. Soifer said he believes the fact the Goodman family has been silent since CI Financial made its unsolicited offer indicates that "they are considering selling."

Shares of DundeeWealth continued to do climb yesterday, closing at its highest price since CI Financial launched its takeover bid.

04 October 2007

4 Banks to Gain from Visa Restructuring

RBC Capital Markets, 4 October 2007

Visa Inc. announced yesterday that it completed a restructuring whereby members would receive shares in Visa Inc. An initial public offering is expected to follow.

CIBC, Royal Bank, TD Bank and Scotiabank announced they they expect to record gains in Q4/07 as a result. Bank of Montreal and National Bank are Mastercard issuers, and should not benefit from the Visa restructuring (they booked gains in 2006 following the restructuring of Mastercard).

We expect the gain to be most material to CIBC, as it is the leader in credit card market share and has the smallest market capitalization.

Lehman Brothers provided a fairness opinion of the value to be received by each Visa entity or member bank. Lehman came up with a valuation range of US$33.9 billion to US$42.3 billion for all of Visa Inc., using both comparable transaction and discounted cash flow methodologies. The share ownership of Canadian members is estimated to be about 2.8%.

We estimate combined after-tax gains of $626 million to $818 million for Canadian Visa issuers, split as follows: 37% CIBC, 29% Royal Bank, 15% TD and 11% Scotiabank. Other Visa issuers in Canada should own approximately 8% of the Canadian allocation, and include Desjardins, Laurentian Bank, Bank of America, Home Trust, JP Morgan Chase Bank, US Bank of Canada and Vancouver City Savings Credit Union.

The main assumptions in our estimates are as follows: (1) the book value on the Canadian banks' books is nil; (2) the tax rate on the gain will be 35%; (3) the valuation banks use is in line with Lehman's fairness opinion (an independent valuation has not been completed yet); (4) the Canadian dollar will be at par with the US dollar; and (5) ultimate ownership will be in line with the estimated ownership given in Visa's regulatory filings (they may change depending on contribution to 2008 earnings).
Reuters, 3 October 2007

Four Canadian banks said Wednesday that they expect to post fourth-quarter gains reflecting the restructuring of credit card company Visa Inc., but they did not say how large the gains might be.

Canadian Imperial Bank of Commerce,Toronto-Dominion Bank, Royal Bank of Canada and Bank of Nova Scotia said they will receive Visa shares for their interests in Visa Canada Association.

The restructuring of Visa, the world's largest credit card network, closed Wednesday and the company plans to go public next year.

CIBC said it expects to book a “material gain” because of its “leadership position” in the Canadian credit card market, but said the exact amount has yet to be finalized.

Visa Canada, Visa U.S.A. and Visa International have become subsidiaries of Visa Inc., based in San Francisco.

Independent valuations of the Canadian banks' Visa stakes are under way, they said.

The banks' fiscal fourth quarters end on Oct. 31.

TD Bank expects to release quarterly results on Nov. 29, while Royal Bank plans to issue its results on Nov. 30. CIBC and Scotiabank will release their numbers on Dec. 6.

Last year, Bank of Montreal and National Bank of Canada recorded gains resulting from the initial public offering of MasterCard.
Bloomberg, David Mildenberg, 3 October 2007

Visa Inc., the world's largest credit-card network, won approval from its member banks to restructure the company before next year's expected initial public stock offering.

Visa will combine its U.S., Canada and international units into a single-stock corporation, the company said in a statement today. London-based Visa Europe will remain a membership association and become a licensee and minority investor in San Francisco-based Visa Inc. after its members on Sept. 27 approved a split.

The Visa network, which processes transactions for banks and credit unions that issue debit and credit cards, has been growing as consumers shift to cards from cash and checks. Last year the company said it planned to combine most of its global businesses and sell shares in 2008 to become more competitive.

``The completion of the restructuring marks a pivotal moment,'' Visa's Chief Executive Officer Joseph Saunders said in the statement. ``We will approach the opportunities ahead in a stronger position than before.''

Mastercard Inc., the second-biggest card company, has risen fourfold in New York Stock Exchange trading since its May 2006 debut. Second-quarter profit excluding one-time items almost doubled to $195 million, or $1.43 a share, though the company beat analysts' estimates by the smallest margin since the IPO.

Visa's value is estimated at $33.9 billion to $42.3 billion, according to a Lehman Brothers analysis included in a regulatory filing last month. The organization is owned by about 16,400 financial-institution customers as of March 31, the company said in the filing. The U.S. Securities and Exchange Commission approved Visa's restructuring on Sept. 13.

The restructuring and eventual IPO are likely to produce one-time gains for member banks. Visa's largest customer, JP Morgan Chase & Co., accounted for 10 percent of Visa's $3.7 billion in revenues in the nine months ending June 30, according to Visa's Sept. 13 regulatory filing.

Four Canadian banks including Canadian Imperial Bank of Commerce, TD Bank Financial Group, Bank of Nova Scotia and Royal Bank of Canada, said today they expect to record undisclosed gains during the fourth quarter from exchanging their interests in Visa Canada Association for Visa Inc.

European regulators fined Visa $14 million today for blocking competition by refusing to let Morgan Stanley offer card services. Visa had barred Morgan Stanley from its system until last year because the second-largest securities firm owned the competing Discover card in the U.S.

Visa Europe said it will appeal the ruling and noted that it settled a lawsuit over the issue with Morgan Stanley last year. Morgan Stanley in June spun off Discover, the fourth- largest U.S. card network.

Visa spokesman Paul Cohen declined to comment on today's announcement.


TD Bank to Buy Commerce Bancorp

The Globe and Mail, Tara Perkins & Andrew Willis, 4 October 2007

Toronto-Dominion Bank chief executive officer Ed Clark has a few challenges ahead of him as he attempts to sell his $8.5-billion (U.S.) acquisition of Commerce Bancorp Inc. to the shareholders of both companies.

TD's shares continued to drop yesterday as a number of analysts downgraded the stock, and a U.S. lawyer told The Globe and Mail that he's planning on launching a lawsuit to try to force the two banks to renegotiate the deal.

Maryland-based lawyer Richard Greenfield, who is already involved in a lawsuit involving Commerce Bancorp, says he is representing a group of about a dozen of the New Jersey-based bank's institutional and individual shareholders who say they are going to sue its board for allegedly breaching its fiduciary duty by accepting TD's takeover offer.

"The board of Commerce was really without a leader," Mr. Greenfield said in an interview late yesterday. "And they jumped at this deal to, in part, try to get out of some of the predicament that they are in and that has been left to them by Vernon Hill, the former CEO."

Mr. Greenfield said his clients collectively hold a "substantial" number of shares that is less than 5 per cent of Commerce's total.

"From what we can tell at this juncture, Toronto-Dominion hasn't done anything wrong that we can see," he added. "From their perspective, they want to buy the assets as cheaply as they can. And they've effectively done that. I think they've got an incredibly good deal for them, but not for the shareholders of Commerce."

The lawyer also complained about a side deal that will see Commerce sell its insurance business to George Norcross, who is a director on Commerce's board. Sources said Commerce Bancorp's financial adviser Goldman Sachs screened a number of potential buyers, including U.S. retail giants Citigroup and Bank of America, but TD was the only bank to enter into negotiations. Analysts say it is extremely uncommon for a regional bank to be purchased in a hostile deal, and believe TD's friendly bid for Commerce will prevail.

In a note to clients yesterday, Genuity Capital Markets analyst Mario Mendonca said that he would not rule out another bidder for Commerce, but he believes TD is in a strong position to complete this deal, partly because of the $330-million (U.S.) break fee Commerce would have to pay if the transaction fell through.

Mr. Mendonca was one of the analysts that downgraded TD's stock yesterday. Canadian banks, including TD, have not demonstrated an ability to pull off big U.S. deals, he said. Moreover, the deal comes with specific risks, such as Commerce's exposure to structured mortgage products, he said.

CIBC World Markets analyst Darko Mihelic also downgraded TD's stock yesterday, because he expects this acquisition to mean a repeat of the messy early days when TD was first integrating its current U.S. banking platform, TD Banknorth.

Even now, Banknorth is still a work in progress and there's limited evidence that TD has successfully turned it around, Mr. Mihelic wrote in a note.

He said the Commerce deal presents "significant integration risks as well as the increasing risk of a weak U.S. economy." TD is effectively "doubling down on U.S.-based earnings ahead of significant economic risk in the U.S."

While analysts downgraded TD shares over the short-term risk, many agreed with Mr. Mihelic's notion that it's probably a good acquisition for shareholders over the longer term, at least "in theory."

In a note to Banknorth employees, TD said some overlapping branches will likely be closed as part of the restructuring that will occur when the two banks are integrated.

Meanwhile, TD CEO Ed Clark said in an e-mail to the bank's employees Tuesday that its stock is facing downward pressure which could last months because Commerce shareholders are selling it short, not because the market doesn't like the long-term prospects of the acquisition of Commerce.

On Tuesday morning, Commerce's U.S. shareholders awoke to the news that their bank will be sold to TD for $42 a share. One-quarter of that price will be paid in cash, while the remainder will be paid using TD shares.
The Globe and Mail, Derek DeCloet, 4 October 2007

Who needs domestic bank mergers? Not Ed Clark.

"I've never been, as you know, necessarily a big fan of Canadian mergers as a way of preserving Canadian financial institutions," His Edness opined the other day, as Toronto-Dominion Bank announced its plan to buy, for $8.5-billion, New Jersey's Commerce Bancorp. "I think it would be better for Canadian banks, if you want to be world players, [to] go out in the world, compete head to head, and prove you're better."

Of course he thinks that. Mr. Clark, more than any other Canadian bank executive, has based his entire strategy on the idea that big bank mergers are DOA in Ottawa - "never going to happen," as he told the Business News Network. But guess what? The banks are making it harder to argue mergers ever need tohappen.

It wasn't always that way. This December will mark 10 years - has it really been that long? - since Royal Bank of Canada's John Cleghorn took his famous walk to see Matt Barrett at Bank of Montreal's Christmas party. Their little eggnog chat led to a merger agreement barely a month later, during which Mr. Cleghorn quipped that he wanted to stop "dicking around on the beach" and Mr. Barrett compared his bank to a local hardware store waiting around for Home Depot to put it out of business.

They made their point badly, but still, they had a point. The major banks, save BMO, were nobodies outside of their home markets. Wouldn't mergers fix this insularity? Mr. Barrett and Mr. Cleghorn thought so. Paul Martin, the Finance Minister who had the final say, disagreed, forcefully. That was in 1998.

And since then? Merger policy has been studied, examined, re-examined, pondered and analyzed to death. The banks have been waiting for a clear signal from Ottawa almost as long as Chicago Cubs fans have been waiting to get to the World Series.

But nothing: Neither Liberals nor Conservatives want to be the ones to tell voters that the greedy rotten banks should be allowed to get bigger. Nor do they want to be seen as anti-capitalist control freaks. So the feds haven't said no to bank mergers; they've said maybe, which is much worse.

"Maybe" is an insidious, paralyzing policy. Maybe is what forces Canadian banks to make lots of little, lower-risk acquisitions in foreign countries, rather than cracking open the vault to make a big one. No banker wants to make an expensive deal and take a hit to his stock price, only to find out two months later that he has become takeover meat because Ottawa lifted the freeze.

But maybe that reticence is now ending, starting with Mr. Clark's play for Commerce Bancorp. With it, TD would have more branches than all but six banks in North America. Less triumphantly, RBC's Gord Nixon has spent close to $4-billion in a month on foreign retail banks, and nobody bats an eye. Yet six years ago, when Mr. Nixon was CEO-in-waiting and the bank spent about $3.5-billion to buy a North Carolina bank, it was a huge story.

Why the difference? Then, RBC was barely a $30-billion bank and now it's a $70-billion bank. TD, in the dark days of 2002, shrank to a market capitalization of $17-billion and now it's more than $50-billion. That's what happens when your financial performance is excellent, and that's the real force behind the Canadian banks' sudden confidence.

It's not the loonie; it's the stock price, stupid. Since Dec. 14, 1998 - the day Mr. Martin killed the RBC-BMO and CIBC-TD merger proposals - the TSX banks index is up 182 per cent. The KBW banks index, a measure of two-dozen leading U.S. banks, is up 47 per cent. You could look it up. U.S. bank investors have lost money in three of the past six years, and are losing again this year. Canadian banks haven't lost since '99.

There are many reasons for this. Our economy has been very good; Canadian bank customers are far more loyal; U.S. banking is simply a crummier business. But the Canadian banks have also gained muscle by pushing around, or sometimes mopping up, a lot of smaller competitors at home. Witness the travails of Coventree or DundeeWealth or (less recently) AIC, and you get a picture of what it's like to compete against them.

Now pretend you're the Finance Minister. You know that every single major bank has been earning returns on equity of 20 per cent (or close to it). You know that there are zero votes to be gained by letting them join together. And now you see that Mr. Clark and Mr. Nixon and Scotiabank's Rick Waugh have billions to throw around and are turning their banks into global ones. So who needs bank mergers?
BMO Capital Markets, 3 October 2007

TD Bank announced on October 2 that it has entered into an agreement to acquire Commerce Bank (CBH-N) for US$8.5 billion, comprised 75% of TD stock and 25% cash. The deal is subject to regulatory and CBH shareholder approval and is expected to close in March/April 2008. There is a break fee equal to 3.9% of the total purchase price.

This deal meaningfully advances TD's retail banking strategy in the U.S. The merged entity, comprised of Banknorth and Commerce, will be a top-five player in most markets in which it competes. Assuming no integration or asset problems, the deal seems to marry a sound deposit gatherer (CBH) with a solid commercial loan franchise (BNK). In addition, the intrinsic growth capability of Commerce Bank should allay the need for more large U.S. Banking acquisitions. Retail banking and Wealth management businesses will make up over 80% of TD Bank's earnings and would argue for a premium multiple versus its peers.

Canadian investors will likely have had limited exposure to Commerce Bancorp. It has been a fast-growing, highly successful retail banking franchise in wealthy parts of the U.S. Northeast with an emphasis on convenience banking. CBH has received industry-leading satisfaction scores from JD Power through a unique combination of strong branch locations, extended hours and a highly visible brand.

The specifics of the asset base of Commerce probably require some comment. The bank is significantly under-loaned, as two thirds of the assets are securities. This carries with it both some risks and opportunities. On the risk front, TD Bank will fair value these securities at the time of close. Commerce Bank has agreed to take losses of US$150 million after tax before closing, to reduce some of the interest rate risk in the portfolio. It is likely that TD will take some more losses at time of closing. We believe that the risk here is very manageable. The securities are insured either by the U.S. government, or one of the government agencies, or are AAA rated. None are backed by subprime and they are all marketable. The opportunity is to add on additional loans (at higher spreads). We believe that TD and Banknorth have the skills to do this relatively easily.

The transaction price of US$8.5 billion is comprised of US$10.50 cash and 0.4142 shares of TD Bank. The multiple is 22.5x 2008 forecast earnings, 13.8x including the full impact of the synergies. On a price-to-book basis, the deal is being advertised at 3x tangible book value; however, this multiple will likely rise once the securities portfolio is fair valued at the time of closing the deal. As a result, goodwill on the deal will likely rise somewhat. Management has estimated cost synergies at $310 million, pre-tax and has not included any revenues synergies. TD Bank will lose about 150 basis points of Tier 1 as a result of this deal.

Forecasts and Conclusions

We are raising our target price on TD Bank to $77 from $75, and are leaving our forecasts unchanged. We were intending to raise our 2008 forecasts (to reflect stronger domestic contribution), and with this increase, we offset the $0.10 of expected dilution from the deal. We note that there is some small potential that another bidder emerges for CBH.

From our perspective, however, this deal places TD in a unique position compared to its Canadian peers. First, it has shifted its business heavily to retail from wholesale. We believe that over 80% of TD's earnings will come from retail banking and wealth management (the average is 65%).

Second, the bank will have critical mass in the U.S. TD will have strong market share positions in most states in which it competes. This complements its excellent position in Canada.

Third, the company does not have to do more large deals to continue growing its non-Canadian footprint. Commerce (like CT) has a well-established strategy of growing de novo. This reduces the need to periodic large transformation deals (such as was announced on October 2 and drove the stock down). We reiterate our Outperform rating on TD.

The move in the stock yesterday (October 2) reflected the significant arbitrage activity as U.S. investors prepared for receiving TD shares (and the stellar performance of the stock over the past month). We believe that the market will, upon review, realize that this deal sees TD complete a transformation from a 'wholesale heavy' Canadian only bank to a global bank with strong positions in most business lines.
RBC Capital Markets, 3 October 2007

We have lowered our 2008E cash EPS to $6.00 from $6.10, reflecting dilution from the transaction, and have lowered our 12-month target price by $1 as a result.

We believe that the US$8.5 billion acquisition of Commerce Bancorp deal makes strategic sense for TD, as it expands the bank's footprint to more rapidly growing areas, provides TD with a model that has led to rapid deposit growth and it further increases the mix of earnings that comes from retail businesses. TD has the ability to add value to the Commerce Bancorp franchise via cost synergies, but also via a greater focus on capitalizing on Commerce Bancorp's deposit base through a larger loan book. We believe that the 5% decline in TD's stock price (representing $2.5 billion of market capitalization) on Tuesday was overdone given (1) the potential strategic benefits; (2) the relatively low premium paid versus the prior day's closing price of Commerce Bancorp (6%); (3) potential annual pre-tax cost synergies of $310 million would add $2.0-2.5 billion in value; (4) expected dilution to EPS is less than 2% in 2008 and neutral in 2009.

TD trades at 12.2x NTM EPS(E), which makes the stock attractive in our view as we believe TD offers better balance of growth and risk than its peers. Domestic retail momentum and higher earnings from the U.S. (driven by cost synergies at TD Ameritrade, and by higher ownership of TD Banknorth and the Commerce Bancorp acquisition) should drive above-average retail earnings growth for TD. We also believe that there is less downside risk to our earnings forecasts for TD than for the industry as the bank is less exposed to wholesale earnings, and appears to have a more conservative mix of businesses within its wholesale division.
Scotia Capital, 3 October 2007

TD Opportunistic Acquisition - Modest Premium of 6%

• TD Bank announced on October 2, 2007 that it intends to acquire Commerce Bancorp for US$8.5 billion or US$42 per share, a modest 6% premium to Monday's closing share price. The transaction will be 75% stock and 25% cash at a fixed exchange ratio of 0.4142 TD shares and US$10.50 per share. The transaction includes a break fee of US$330 million or 3.9%.

• The transaction is expected to close in March or April 2008.

• The market reacted negatively to the transaction with TD's share price declining $3.79 per share or 5.0% reducing the bank's market capitalization by $2.7 billion or 32% of the acquisition value which we believe is excessive. TD shares have been reaching new highs in the previous week, which likely contributed to the weakness.

• TD is expected to issue 85.3 million shares representing a 12% increase in shares outstanding.

Purchase Price

• According to TD management, the transaction price represents 22.5x 2008 earnings, 2.96x tangible book value, and a 13.5% core deposit premium. TD anticipates US$310 million pretax in synergies representing a post-synergy multiple of 13.8x 2008 earnings.

• The purchase price of this transaction generally compares favourably to the median of transactions greater than $6 billion since 2004 on a NTM P/E basis including synergies and a tangible book value basis. The acquisition appears to be very inexpensive on a core deposit premium basis with TD paying a 13.5% premium versus median of 38.1%. The transaction appears to be in line with other transactions based on other metrics.

Mildly Dilutive in Year 1, Neutral in Year 2 - Restructuring Charge

• In conjunction with the transaction, TD will take a restructuring charge of approximately US$490 million pre-tax. TD expects the acquisition to be ten cents, or 1.6%, dilutive on an adjusted earnings basis in 2008 and neutral in 2009. TD is projecting C$1.2 billion in earnings in 2009 for its U.S. P&C Banking segment or 25% of estimated TD Bank earnings.

• Tier 1 ratio is expected to decline to within the 8.75% to 9.0% range from 10.2% with tangible common equity to risk-weighted assets estimated at 7.5% to 7.75% at closing.

• Commerce Bank intends to sell a portion of its fixed-rate investment securities and reinvest in floating rate securities in order to limit the bank's exposure to changes in interest rates. As a result, CBH anticipates an after-tax charge of US$150 million in the third quarter. In addition, CBH will sell Commerce Banc Insurance Services Inc., to founder George Norcross.

Acquisition Creates Critical Mass in U.S.

• The acquisition will give TD critical mass in the U.S. with a combined footprint of over 1,000 branches. Commerce Bank has 460 branches and 700 ATMs in New Jersey, New York, Connecticut, Pennsylvania, Delaware, Washington, DC, Virginia, Maryland and Florida.

• TD has improved market position in five of the ten largest and wealthiest markets in the U.S. including New York City, Miami, Philadelphia, Washington and Boston.

• CBH is deposit rich with US$100 million deposits per branch, US$48 billion in assets, US$44 billion in deposits and US$16 billion in loans.

Strong Cultural Fit

• CBH is primarily a retail bank offering personal and commercial banking, insurance, investment planning and wealth management. CBH is focused on organic growth and has customer satisfaction as its top priority.

• Commerce Bancorp is considered one of the most customer friendly banks in the U.S.


• Our 2007 and 2008 earnings estimates remain unchanged at $5.80 per share and $6.30 per share, respectively, as we expect estimated 2008 earnings dilution from the transaction to be offset by improving operating performance.

• Maintain 1-Sector Outperform based on TD's superior profitability, especially return on risk weighted assets, and favourable business mix with wholesale earnings expected to decline from the current 22% of earnings to 15% earnings assisted by this acquisition.
Financial Post, Duncan Mavin, 3 October 2007

Toronto-Dominion Bank’s U.S. mega-deal has certainly woken up the sometimes staid Canadian banking sector. But the transaction, which transforms TD Banknorth — TD’s struggling U.S. retail banking operation — might not do much for the bank in the short term, say analysts.

“While TD Bank's shares have recently earned a reprieve from the ‘Banknorth penalty box’ for a variety of reasons, this transaction will put them back in there as investors take a ‘wait and see’ approach,” says Credit Suisse analyst Jim Bantis.

For now, the transaction disrupts Banknorth’s focus on organic growth and increases TD’s exposure to the weakening U.S. economy, says Mr.Bantis.

National Bank analyst Rob Sedran adds that, “Near-term financial implications are negative,” because TD’s balance sheet is already stretched to accommodate the privatization of Banknorth earlier this year.

Despite the short term concerns, both Mr. Bantis and Mr. Sedran say the deal will look better in the longer term. The US$8.5-billion deal for Commerce Bancorp Inc will be perceived as the right decision in five years, says Mr.Bantis.

“At this point of the TD Banknorth strategy, missing out on the eventual consolidation of the mid-Atlantic region would not have been an option for TD management,” he says.

For now, the Credit Suisse analyst downgraded his rating on TD’s stock from outperform to neutral. Mr.Sedran maintains an outperform rating on TD.
Financial Times, 3 October 2007

Generating a wow factor, handing out dog biscuits to customers’ pets, penny arcades. These are some of Commerce Bancorp’s gimmicks for keeping its “fans” happy. But it was the bank’s investors who had the most fun on Tuesday: Toronto-Dominion Bank’s $8.5bn offer for their company works out at a 22.5 times forecast earnings.

This is a risky move for TD. It is earnings dilutive to start, which, though an imperfect measure of the economics, is widely noted by investors. It is also an exciting move. First, there is a good cultural fit. This is key because Commerce’s impressive track record in deposit-gathering relies on a particular culture that could easily be broken by a knife-wielding, cost-cutting takeover.

But TD cannot just rely on deposit growth to make the deal stack up. Its initial return on capital will be an underwhelming 7 per cent. To hit the more impressive internal rate of return of 15 per cent later on, TD surely has to improve on Commerce’s net interest margins. There are several ways of doing this, and the most obvious way is to be more aggressive with Commerce’s deposits. Currently, Commerce has an unusually low ratio of loans-to-deposits. It invests some of the deposits in securities, which in the current yield environment is hard going. In fact, it will lead to a large charge in Commerce’s third quarter, as disclosed on Tuesday amid the news of the takeover. If TD puts more of Commerce’s deposits to work as loans, and comes up with more products that customers pay fees for, it should be able to boost margins.

TD should also, of course, be able to cut costs, though the branch culture will probably be left alone. Still, that leaves a lot of non-branch costs to be trimmed. There are not many banks, for instance, that boast a 65,000 sq ft university to train staff.
The Globe and Mail, Fabrice Taylor, 3 October 2007

Where would Ed Clark be without his loyal retail base? Probably not making splashy acquisitions in New Jersey.

The Commerce Bancorp deal looks like a good one, but it's a lot easier to pull off with the kind of multiple Mr. Clark, TD's CEO, enjoys. Before yesterday's news, according to Thomson Financial, TD had the highest price-to-earnings ratio of all the big five banks, even RBC. A high Canadian dollar is nice, but when three-quarters of the deal is paid in stock, a high valuation is nicer. Does the bank deserve its multiple? Investors certainly think so, and the numbers are compelling.

TD derives a high proportion of its earnings from retail banking - more than half of earnings comes from the Canadian personal and commercial segment. That's higher than most other banks. And TD is more profitable. An institutional investor in the Vox Witness Protection Program says TD's branches earn about $2.2-million each. RBC is higher at $2.6-million, but the rest of the pack lags at about $1.5-million.

How does TD achieve this? Partly from applying the Canada Trust retail model to the branch network, including longer hours and more staff who can sell products.

It appears that Canadian consumers pay up for convenience because TD also has a low-cost deposit base, meaning it gets away with paying less than other banks for the money it borrows from you and I when we leave cash in the bank.

Mr. Clark, of course, ran Canada Trust when it was bought by TD, and he's now turning TD into a bigger version of his former employer. There's room for plenty of organic growth. For example, the bank is slowly turning most of its branches into the more retail-friendly models. That, with a healthy investment in technology matched only by RBC, means more selling. It also means TD can add more wealth management.

Compared to RBC (our institutional investor figures there's two camps of bank in this country: TD and RBC in one, the rest in another), TD has room to grow its wealth management offering by putting more brokers and financial planning types in branches. RBC has pretty much tapped out its opportunities. Higher organic growth potential means a higher multiple. In this case, the case for growth looks pretty solid. Investors clearly think the profitability gap between the two top banks is closing.

Focusing on boring retail has spared TD some of the expensive blunders of its peers. The bank made a decision to exit or not enter the kinds of businesses that are causing other lenders so much trouble these days. It has no subprime CDO exposure, no liquidity lines to suspect issuers, no investments in toxic asset-backed commercial paper.

That explains why the stock recovered so much from the lows it hit in August, shooting from $66 to $76 in about six weeks, outperforming all of its rivals except CIBC.

So the timing of this acquisition couldn't have been better. TD gets to use a strong currency - or currencies, dollars and its stock - to buy what many analysts describe as the Canada Trust of the U.S., with $43 billion in low-cost deposits that are growing at a double digit clip, along with branches - or stores, as Commerce Bancorp calls them. To put that number in perspective, TD has about $150-billion in personal deposits, so it's a big leap.

Investors aren't as nervous about this deal as the sharp drop in TD's stock price suggests. A lot of that drop is arbitragers selling TD short and buying Commerce shares to earn a fairly safe spread.

But there's no doubt that some doubters will worry about earnings dilution in the short term. They shouldn't necessarily. It's really not hard to make earnings accretive deals that nonetheless dilute your return on capital. Most big acquisitions worth making will trim earnings for a while.

If this one works out like Canada Trust did, that dilution will soon be forgotten and Mr. Clark's halo will be even brighter. And all because he banked on the little guy.
The Globe and Mail, Andrew Willis, 3 October 2007

Canadian bankers wait their whole careers for this kind of market.

For Ed Clark and Gord Nixon, heads of Toronto-Dominion Bank and Royal Bank of Canada, respectively, the past few years have been a period of restraint. At a time when U.S. regional banks boasted sky-high valuations, and plenty of deals played out, both chief executive officers focused on fixing up their U.S. branch networks and setting aside capital.

In August, the world changed. U.S. regional bank stocks nosedived on well-founded concerns about the banks' exposures to subprime mortgages. Credit became scarce and private equity funds, long the deep-pocketed winners of corporate auctions, pulled in their horns. And as the loonie soared, so did the valuation on Canadian banks, which enhanced the Canadian CEOs' ability to pay for takeovers with their own shares.

The bankers responded with panache yesterday: TD Bank launched a bold $8.5-billion (U.S.) bid for Commerce Bancorp Inc. while RBC landed a dominant position in Caribbean banking.

RBC made its move with the $2.2-billion purchase of RBTT Financial Holdings Ltd., just weeks after dropping $1.6-billion on an Alabama bank. John Aitken, an analyst at Dundee Securities, said: "We would not be surprised to see other Canadian financial institutions make large acquisitions in the United States in the near future."

For banks and insurers with U.S. expansion strategies, this is the time to move. Canadian banks "sit in a relatively strong position" versus their U.S. peers, Kenneth Usdin at Bank of America said in a note yesterday titled "The Canadians are Coming."

"Canadian banks have seen strong appreciation of their stocks over the past few years, significantly outperforming most U.S. peers," Mr. Usdin wrote. "Valuations have improved and market caps have grown, improving relative comparisons on both metrics. Further, the Canadian dollar has appreciated versus the U.S. dollar."

In addition to strong balance sheers, Canadian financial service CEOs are largely confident, based on past deals, that they can meet the challenges that come with integrating operations. Mr. Clark, for example, keeps and consults binders full of notes on the IT and personnel lessons learned from combining TD Bank with Canada Trust.

"The Canadian banks, and their boards, know that they can execute the basic, but profitable, blocking and tackling that's needed to run retail banks. Where they are less confident, understandably, is in the riskier businesses, such as U.S. wholesale [investment] banking," said one corporate financier who has worked on acquisitions with a number of banks.

Who will move next? All three major life insurers have shown the ability and desire to do foreign acquisitions, as have two other big banks: Bank of Nova Scotia and Bank of Montreal. The only wallflowers are Canadian Imperial Bank of Commerce and National Bank of Canada; neither has an existing American retail platform.

Analysts have already made their forecasts on who might marry up next; here is a selection of their predictions:

BMO is said to be looking at a $3.5-billion-plus acquisition of Minnesota-based TCF Financial, which has 446 branches and 5,600 employees..

Manulife Financial Corp. has been seen by analysts as interested in three firms: Principal Financial Group, based in Iowa; Nationwide Financial Services of Ohio and British insurer Prudential PLC.

Sun Life Financial Inc. paid $650-million for a U.S. benefits company last year and is expected to keep doing similar-sized transactions.

Power Financial Corp. is seen as on the prowl, even though its Great-West Lifeco Inc. subsidiary is digesting last year's $4.6-billion acquisition of Putnam Investment Trust, the 10th-largest U.S. mutual fund company.
Financial Post, Peter Morton, 3 October 2007

Founded by a man who once owned 40 Burger King restaurants, Commerce Bancorp is certainly one of the most unusual banking chains in the complex U.S. financial-institutional environment.

It calls itself "America's most convenient bank" and its 460-plus branches and 700 ATMs through New Jersey, New York, Connecticut, Pennsylvania, Virginia and Maryland, and even as far as Florida, are modelled more after a perky fast-food restaurant than a dour bank.

The outlets are trimmed in red, it has a seven-day lobby or drive-through operations, free coin-counting (even for non-customers) as well as free lollipops and dog biscuits in its branch lobbies.

Last year, it gave away 28 million pens as well as innumerable coffee mugs. It was also one of the pioneers of U.S. banking for fee-free personal chequing accounts as well as instant ATM cards, online banking and stock trades.

Better yet, it has used popular television talk-show hosts Kelly Ripa and Regis Philbin in its "have it your way" commercials that emphasize its customer-friendly approach .

A rarity in the banking business, Commerce, sold yesterday to Toronto-based Toronto-Dominion Bank, was created from scratch in 1973 in Cherry Hill, N.J., by Vernon Hill, who was also a real-estate developer. Since then, its annual revenues have ballooned to US$1.6-billion and it now has a market capitalization of US$7.6-billion, which ranks it third among 146 regional U.S. banks.

It also has 2.4 million customers, assets of US$48-billion and deposits of US$44-billion. Commerce also has about 15,000 employees.

The unique hands-on approach of Mr. Hill has certainly played a role in the bank's operations -- and in some of its woes. He ran into trouble with regulators when he tried to run the bank a little too much like his real-estate and fast-food outfits.

The U.S. Office of the Comptroller of the Currency and the Federal Reserve Bank of Philadelphia launched a probe several years ago into some of the services Commerce used, including a company created by Mr. Hill to look for new branch locations and another owned by his wife that decorated new branches.

In the end, Mr. Hill resigned this summer from an active role in the bank and Commerce itself pledged to end deals with company insiders. He still owns about 2.6 million of the 193 million shares outstanding. Analysts speculated the legal woes and ultimate departure of Mr. Hill in June meant the company would soon be up for sale.

Yesterday, some analysts wondered how Mr. Hill's departure would affect the bank and its new owners.

"The culture of the Commerce bank branches is going to be difficult to maintain, if not impossible to maintain," said RBC Capital Markets New York analyst Gerard Cassidy. "He was the life and the blood of that organization. When he left, it was taking the heart out."

Ed Clark, chief executive of TD Bank, insisted yesterday the changes would not "impact growth" of the bank. But one thing that may change soon is Commerce Bancorp's sometimes all-too-friendly approach to retail banking.

The police in New York and New Jersey have warned Commerce its outlets are less than robbery-resistant and have been hit many times in the New York and New Jersey area because they keep late hours and do not have bulletproof glass at tellers' windows.
Financial Post, Sean Silcoff, 3 October 2007

Canadian banks firms are not known for their daring, ingenuity or cunning. Mostly, they make a lot of money in the protected Canadian retail market and keep investors happy. Their growth outside Canada has, for the most part, been low-key and timid.

Until yesterday, that is, when Toronto-Dominion Bank kicked into high gear CEO Ed Clark's plan to become a major force in U.S. retail banking. TD said it will pay US$8.5-billion in cash and stock for the 444-branch Commerce Bancorp Inc., after dropping US$8.4-billion since 2005 on its other U.S. retail bank, TD Banknorth.

TD's purchase of CommBanc suggests our closeted banks are ready for a real battle. TD has bravely chosen 'Go Big' over 'Go Home.' Or, just maybe, it has no idea what it's getting itself into.

TD's track record in U.S. retail banking is not great. The strategy at Portland, Me.-based TD Banknorth has shifted constantly in the nearly three years since TD said it would buy control of the firm. After initially saying it would stick by the management team, Mr. Clark instead parachuted in his own man, Bharat Masrani, as CEO last year. TD had planned to use Banknorth as a vehicle to buy banks with US$15-billion in assets, but its two deals before yesterday were a fraction of that size. Banknorth, which had a good reputation for integrating deals, struggled with its two purchases. Profits are down, and early this year, the U.S. bank said it wouldn't buy anything until 2008, as it focused on costs and service.

If TD's herky-jerky U.S. strategy has been hard for investors to follow, just wait for the Commerce Bancorp experience.

CommBanc is an exotic animal in the world of banking. Founder Vernon W. Hill II's story is classic all-American entrepreneur. In 1973, the owner of 40 Burger King outlets decided he could apply fast-food customer service to banking. His well-appointed branches -- he called them 'stores' -- stayed open at night and on weekends. He installed coin-counting machines so kids could change their pennies for bills, and gave out lollipops. Dogs were welcome and even got biscuits. "Banking should be fun," Mr. Hill once said. It was so for employees, who were treated to team-building sessions that would make Wal-Mart blush, let alone other banks. CommBanc held pep rallies at Radio City Music Hall -- with Rockettes in the house --and gave away sports cars to top-performing managers.

CommBanc's ATM machines were fee-free and customers were even reimbursed when they were dinged elsewhere. In an era of industry rationalization, CommBanc's high-touch approach helped it steal other banks' customers and grow fast. Its motto was "America's most convenient bank" and Fast Company heralded Mr. Hill as one of the "most original minds in business," a phrase that has never appeared alongside the name of a Canadian bank CEO.

CommBanc barrelled into the New York City market, where it quickly became a fixture. "They've got more guts than I have" to go to New York, Mr. Clark told the Post. "They were completely fearless."

Does that sound like a fit with TD, where the definition of bold thinking is giving iPods to new customers instead of toasters? "We know we can absorb this culture," Mr. Clark said.

That's hopeful, or naive. CommBanc is a high-speed train of a firm, only now it is without its conductor. Mr. Hill was forced by U.S. regulators to quit as chairman and CEO last summer after CommBanc funnelled US$50-million worth of business to his wife's firm (she designed the branches), and gave contracts to his brother and son. Two executives were recently convicted of conspiracy for giving loans to Philadelphia's city treasurer in exchange for its financial business.

Leave aside the unseemly details and you're left with one nagging concern: The larger-than-life entrepreneur that built the bank is gone, along with the verve he poured into stealing the business and loyalty of customers from other banks. It would be hard to replace a rare visionary in such a grey-faced industry with anyone other than an outsider, and banks are not exactly beacons for outsiders. More likely, TD will install a veteran bank executive who will focus on improving CommBanc's relatively low profits (which resulted from its high-touch service) while missing the point of how it got to where it is. Will customers continue to love CommBanc? Early signs are not good. Second-quarter profits -- after the CEO left -- were down 5%. An analyst report in August said the quality of customer service had fallen sharply.

Mr. Clark seized a rare opportunity to buy a large U.S. bank, when the loonie is strong and the U.S. economy is weak. Maybe he can break out of Canada and show TD belongs on the world stage. Or maybe he's buying himself a big problem.
Financial Post, Grant Surridge And Duncan Mavin, 3 October 2007

Only a few months ago, Ed Clark, chief executive of Toronto- Dominion Bank, said he would face a "real dilemma" if tough conditions in the U.S. banking sector presented the opportunity for an acquisition before he was done tidying up the bank's existing Banknorth franchise in the country.

But circumstance changed, and the chance to buy New Jersey-based Commerce Bancorp Inc. could not be passed up when a convergence of factors, including a surging loonie, an executive scandal and low financial-services sector valuations, made the deal possible.

Yesterday, TD agreed to a 75%-stock and 25%-cash deal worth US$8.5-billion to buy Commerce.

"If you are not willing to buy the most convenient bank in the marketplace at a time when you can finally afford it, you should say, 'Go home,' " Mr. Clark said yesterday. "You don't really want to be a great North American player."

The combination of Commerce with TD Banknorth would give TD a "critical mass" south of the border, he said, doubling its retail-banking business and giving it 2,100 branches and total deposits, including those in Canada, of about US$250-billion.

TD says the deal would make it the seventh-largest bank in North America, measured by number of branches. It would also have the largest branch network on the continent among Canadian banks.

The recent surge in the Canadian dollar made the deal attractive, said Mr. Clark, as did the departure of Commerce's chairman and chief executive at the end of June after an investigation by U.S. regulators into business dealings he had with his family.

The U.S. bank's board demanded Vernon Hill II, who founded the company, resign as part of a deal with the Office of the Comptroller of the Currency and the Federal Reserve Bank in Philadelphia.

"I've always watched [Commerce], but it never occurred to me it would come for sale because of the entrepreneur power driver who was never going to sell the company," Mr. Clark said.

In a conference call yesterday, TD executives reiterated that Commerce does not have any exposure to the U.S. sub-prime-mortgage market.

Commerce is a fast-growing retail bank that has shaken up some markets by offering better service, such as extended hours. The model is similar to TD's domestic retail bank, widely considered to have the highest level of retail customer service among the big Canadian banks.

Commerce has about 460 locations in the northeastern United States and southern Florida, with US$48-billion in assets and more than 15,000 employees.

In March, 2005, TD made its first foray into U.S. retail banking by completing a US$3.8-billion deal to purchase a 51% stake in Maine-based Banknorth Group Inc.

TD said management teams at both Banknorth and Commerce would remain in place.

"We view this transaction quite positively, given the significant scale in terms of both branches and deposit base," wrote Dundee Securities Corp. analyst John Aiken in a note. He has a "market neutral" rating on the stock.

TD took advantage of the strong Canadian dollar and the discounted valuations of U.S. financial stocks, wrote Mr. Aiken, adding he would not be surprised to see other Canadian financial companies soon make large acquisitions in the United States.

Commerce shareholders will receive about 0.4 of one TD common share and US$10.50 in cash for each common share of Commerce. Based on the Oct. 1 closing price of TD stock, the deal values Commerce at US$42 per share, or about 6% higher than its Monday closing price of US$39.74.

Despite the relatively slim premium, many investors didn't like the offfer, driving TD's shares down $3.79, or almost 5%, to close at $72.54.

The deal is scheduled to close next spring subject to regulatory approval, assuming another U.S. bank does not come in and make a topping offer.

Mr. Clark said he is confident the same service standards can be implemented at Banknorth and Commerce, and said he has long admired Commerce's strategy of organic growth.

"They've got more guts than I have, they have gone into Manhattan in the last four or five years and took Manhattan and they were completely fearless."
The Wall Street Journal, Robin Sidel, 3 October 2007

Yesterday, Toronto-Dominion Bank snapped up Commerce Bancorp Inc., a regional mid-Atlantic bank that has in the past decade helped revive the banking industry's passion for branch banking. Commerce's founder, Vernon Hill, was ousted from its leadership in June after a series of governance scandals.

The $8.5 billion cash-and-stock deal represents the latest in a recent string of Canadian-led banking deals. Also yesterday, Royal Bank of Canada agreed to acquire Caribbean-based RBTT Financial Group for $2.2 billion. That deal came on the heels of RBC's move last month to buy Alabama National Bancorp for $1.6 billion, representing its biggest-ever U.S. transaction.

The Canadian dollar has surged against the U.S. dollar in recent weeks, spurred by high commodity prices and a strong Canadian economy. The two currencies last month reached parity for the first time since 1976. Late yesterday in New York, one dollar bought 99.76 Canadian cents. In comparison, five years ago, one dollar bought 1.5868 Canadian dollars.

As a result, Canadian companies, which have spent the past couple of years shedding debt and cleaning up their balance sheets, are poised to spend their loonies, named after the Canadian fowl emblazoned on the currency.

"The Canadian corporate sector is in good shape, and now they have the currency to make some acquisitions," says David Wolf, chief Canadian strategist for Merrill Lynch & Co.

Among industries, Canadian financial institutions are expected to be particularly aggressive, because many U.S. banks have been battered by the summer's rout in credit markets and fallout from the subprime-mortgage mess. Further, these banks largely expect loan delinquencies and charge-offs to rise in coming months from historic low levels. Those factors could lead to declining stock-market values for U.S. regional banks. At the same time, large U.S. banks that might be typical buyers are also dealing with the same problems and may be hesitant to pursue a big deal.

"The strong Canadian dollar and weakening U.S. credit environment give the Canadian-based banks a unique opportunity to extend any strategies that they have in place," says Brad Smith, senior financial-services analyst at Blackmont Capital Inc., a unit of CI Financial Income Fund, a Toronto-based wealth-management company.

Indeed, the strong currency played a role in Toronto-Dominion's decision to grab the Cherry Hill, N.J., bank. Commerce, which has nearly 460 branches in 10 mid-Atlantic states, is well regarded for its deposit-gathering and strong customer-service culture, which treats branches as "stores." The bank's branches typically are open long hours -- including Sunday -- and are known for low fees and free services such as automatic coin-counting machines.

Toronto-Dominion already has a U.S. banking foothold with TD Banknorth, which is based in Portland, Maine, and has nearly 600 branches in eight states in the Northeast. Toronto-Dominion also bought in 2005 a 39% stake in discount brokerage firm Ameritrade Holding Corp., now TD Ameritrade Holding Corp.

Commerce had widely been considered a likely takeover target since June, when Mr. Hill was forced out of the company after a string of governance missteps, including paying his wife's interior-decorating firm to perform work on the bank's branches. With Commerce's unique corporate culture making it difficult to integrate with a large U.S. bank, most industry analysts had speculated that a foreign bank would be the likely buyer.

Ed Clark, president and chief executive of Toronto-Dominion, says he had long coveted Commerce and jumped at the chance to buy the company following Mr. Hill's departure. The rise of the Canadian dollar, he says, helped make the deal more appealing.

"We would have done it if the dollar hadn't moved up, but we got real lucky, because it changed the economics of the transaction dramatically," he said, noting that a weaker Canadian dollar would have made the deal dilutive to Toronto-Dominion's shareholders.

A weaker Canadian dollar didn't stop Toronto-Dominion from acquiring Banknorth in 2004, though Mr. Clark can't forget the weak U.S.-Canadian exchange rate at that time -- "77 cents," he said with a laugh yesterday.

Although the Canadian dollar's strength may have been a positive for Toronto-Dominion, some Commerce shareholders had been hoping for a richer price. At the time of Mr. Hill's ouster, some analysts had estimated the stock could be worth some $44 a share, even as the bank was still dealing with assorted regulatory issues tied to real-estate and vendor transactions. The implied value of yesterday's deal was about $42 a share.

"We suspect the reason that the deal price was a bit lower than we predicted was because Commerce was negotiating from a position of weakness, and many of the logical buyers were not in a position to consider this acquisition," wrote Mark Fitzgibbon, an analyst at Sandler O'Neill Partners, in a research report.

Commerce shares fell 14 cents to $39.47 in 4 p.m. New York Stock Exchange composite trading.
The Globe and Mail, John Partridge, 3 October 2007

Toronto-Dominion Bank chief executive Ed Clark is orchestrating one of the biggest foreign takeovers in Bay Street history, an $8.5-billion (U.S.) deal for New Jersey-based Commerce Bancorp Inc. that will propel TD up the ranks to become the seventh-largest bank in North America.

If TD pulls it off as expected by next spring, roughly half of its 2,100 branches will be in the United States.

“We are the first North American bank,” Mr. Clark declared, taking a not too subtle jab at rivals, such as Royal Bank of Canada and Bank of Montreal.

Commerce Bancorp has nearly 460 locations throughout New Jersey, New York, Connecticut, Pennsylvania, Delaware, Washington, D.C., Virginia, Maryland and Southeast Florida. Its footprint covers five of the largest and wealthiest urban markets in the U.S., and the population in the areas it serves is bigger than that of Canada.

Mr. Clark said TD's been worried for some time about how to keep up the 15-per-cent annual pace of growth in its Canadian consumer banking operations. “It has to, by definition, slow down,” he said in an interview.

“Clearly, the United States offers way higher growth.”

Canada's mature banking market means all of Canada's big banks will be increasingly turning their attention south, according to Brenda Lum, a banking analyst at Toronto-based DBRS Ltd.

“I think that Canada provides a core, stable base of earnings and revenue,” Ms. Lum said.

The challenge domestically is that, with a handful of dominant banks, market share gains often come at the expense of revenue, because one of the few ways to make any sizable gains is by dropping prices.

“So, I think longer term, if you want to grow meaningfully, then to be a medium-sized fish in a bigger pond will make it easier,” Ms. Lum said.

TD has already hunted down at least 100 new sites where it can open branches in Commerce's neighbourhoods in coming years. With an average of more than $100-million in deposits in each of its branches, Commerce beats the industry average of between $50-million and $70-million, Mr. Clark said.

Just a few short months ago, the prospect of missing out on a big purchase was haunting him. That's because TD is still fixing up its existing U.S. bank, TD Banknorth, for which it paid a total of about $9.1-billion (Canadian) in separate transactions. Mr. Clark wanted to give it time to “get its game plan down” and grow on its own.

“My nightmare scenario is that something comes along that's strategic that I really can't miss, and it comes out at a price that I'm prepared to pay,” he told analysts in August. But when that scenario played out, for Mr. Clark, it became a dream come true.

He'd had his eye on Commerce for years, and the stars aligned for him recently. First Commerce put itself up for sale after replacing its former CEO, who is being investigated for deals he did with companies controlled by his relatives. Then the loonie hit par with the U.S. dollar in the middle of negotiations. And TD's stock was strong thanks to its lack of exposure to U.S. subprime mortgages and related areas, Mr. Clark said. The acquisition had become very affordable.

“Sometimes you just don't get to choose your timing,” he said.

He said he's found a “low-risk way” to continue his U.S. expansion. But the size of his gamble on a bank that's had trouble with regulators and an allegedly self-dealing executive carries risks. TD could also find it hard to find cash to spare for other opportunities that might arise in the near future, such as expanding its U.S. discount brokerage operations. TD owns about 40 per cent of TD Ameritrade Holding Corp.

The takeover of Commerce is worth more than 15 per cent of TD's market value, BMO Nesbitt Burns Inc. analyst Steve Theriault noted. Three-quarters of the deal will be paid for with stock, meaning TD will also find itself with a growing U.S. shareholder base.

He said the key challenge is “de-risking” Commerce's balance sheet. Its $28-billion (U.S.) securities portfolio stood at nearly 60 per cent of its total assets at the end of June, which is well above TD's comfort level, he said.

Commerce has agreed to clean up its balance sheet, with the goal of reducing its exposure to changes in interest rates, TD said. Those actions will result in an after-tax charge of about $150-million in the third quarter.

TD Banknorth CEO Bharat Masrani will be running the show as TD puts in place a 12- to 18-month integration strategy. Initially, the two banks will run separately, with Commerce's management reporting to him. Mr. Clark has no doubts that TD knows how to run a large American bank.

“We know that if you look at our statistics on customer attrition, or cross-sell ratios, or customer service, we're better than Bank of America, we're better than Wells Fargo, we're better than any of these big American banks,” he said.

He says he's never been a big fan of using Canadian mergers as the best avenue for growth.

“I think it would be better for Canadian banks, if you want to be world players, [to] go out in the world, compete head to head, and prove you're better.”
Bloomberg, David Scanlan and Bradley Keoun, 2 October 2007

Toronto-Dominion Bank, in the biggest foreign takeover by a Canadian lender, agreed to pay $8.5 billion for Commerce Bancorp Inc., the New Jersey company that ousted founder Vernon Hill three months ago.

Shareholders of Commerce, the state's largest bank, will get about $42.37 a share in cash and stock, or 6.6 percent more than yesterday's closing price, Toronto-Dominion said in a statement today. Toronto-Dominion shares fell the most in five years after the bank said the purchase will reduce profit in 2008 and 2009.

The 62 percent surge in the Canadian dollar since 2002 has increased Toronto-Dominion's market value to more than $52 billion, making foreign acquisitions cheaper for Canada's third- biggest bank. Commerce decided to sell after replacing Hill, the former chief executive officer, whose dealings with companies controlled by family members prompted a U.S. investigation.

Toronto-Dominion "is striking while the iron is hot, with the Canadian dollar at parity,'' said Gavin Graham, who helps oversee about $5.3 billion as chief investment officer at Guardian Group of Funds in Toronto. ``It may be dilutive to earnings in the short term. But TD is making itself into a powerhouse in the northeastern United States.''

The Toronto-based bank already owns Portland, Maine-based TD Banknorth, and Hudson United Bancorp in Mahwah, New Jersey. With the purchase of Commerce, based in Cherry Hill, Toronto- Dominion will double its U.S. business, adding almost 460 outlets and $48 billion in assets across nine states.

Toronto-Dominion's acquisition would be the third-largest foreign transaction for a Canadian company, trailing Manulife Financial Corp.'s purchase of John Hancock Financial Services in 2003 and the takeover of Reuters Group Plc by Thomson Corp. this year, according to data compiled by Bloomberg.

Canadian banks have announced or completed about $18 billion in acquisitions this year of banks in the U.S., Latin America and the Caribbean, taking advantage of the soaring dollar. The Canadian dollar reached equal value with the U.S. currency last month for the first time since 1976.

Royal Bank of Canada, the country's biggest bank, agreed today to buy RBTT Financial Holdings Ltd. in Trinidad and Tobago for $2.2 billion. Bank of Nova Scotia, the second-biggest bank, agreed in August to buy a lender in Chile for about $1 billion.

Toronto-Dominion declined $4.29, or 5.6 percent, to $72.65 in New York Stock Exchange trading, the biggest decline since July 19, 2002. Commerce fell 14 cents to $39.47.

The Commerce purchase will be made with 75 percent stock and 25 percent cash. The Canadian company offered 0.4142 share and $10.50 in cash for each Commerce share. That's $42.37 a share based on Toronto-Dominion's closing share price yesterday. The offer has a breakup fee of 3.9 percent, payable to Toronto- Dominion, if it isn't completed.

The purchase adds to Banknorth's 600 branches and $40 billion in assets in New England and other northeastern states, making Toronto-Dominion the seventh-largest bank in North America by number of branches.

The offer equals about 2.8 times book value for Commerce, compared with the median price of 2.5 times book value for U.S. transactions of more than $6 billion since 2004, the bank said.

``A great franchise became available unexpectedly'' at the same time that the Canadian dollar was rising, said Toronto- Dominion Chief Executive Officer Edmund Clark. ``We have achieved critical mass in the United States.''

Commerce has branches in the New York and Philadelphia metropolitan areas, including about 25 in Manhattan, and around Washington and in Florida. The bank has about 15,000 employees and 2.4 million customers.

Hill, a former real estate developer who founded the bank in 1973, increased assets by more than 16-fold from 1995 through June. The red-trimmed branches were built to look alike, part of a branding idea that Hill said he got partly from his ownership of more than 40 Burger King restaurants.

Commerce said it would replace Hill in June when it agreed to settle a probe by the federal Office of the Comptroller of the Currency and the Federal Reserve Bank of Philadelphia.

The agencies were scrutinizing properties and business services provided by companies that Hill's family controlled. A company started by Hill was asked to search out potential branch locations for the bank, and a company owned by his wife decorated the branches. As part of the settlement with regulators, Commerce promised to end those arrangements and forbid new deals involving company insiders.

Toronto-Dominion's Clark told investors on the conference call that he's ``confident these issues will not impact growth.'' OCC spokesman Kevin Mukri declined to comment on the acquisition.``The culture of the Commerce bank branches is going to be difficult to maintain if not impossible to maintain,'' RBC Capital Markets analyst Gerard Cassidy said. Keeping branches open seven days a week, one of the perks Commerce offered customers, may prove too costly to continue, he said.

A sale was inevitable once Hill was removed, Cassidy said.

"He was the life and the blood of that organization,'' Cassidy said. ``When he left, it was taking the heart out.''

The Canadian bank will take a pretax charge of $490 million after the purchase is complete for ``technology and human resources'' costs, Colleen Johnston, the chief financial officer, said on a conference call today. The costs aren't related to any securities owned by Commerce.

The bank expects to reduce costs by about $310 million with the merger, starting in 2009, she said. The current management at Commerce will remain, reporting to Bharat Masrani, CEO of TD Banknorth, the banks said. Commerce will record costs of about $150 million in the third quarter after it sells some of its fixed-income securities at a loss.

JPMorgan Chase & Co. and Keefe Bruyette & Woods advised Toronto-Dominion, with Simpson Thacher & Bartlett LLP as legal advisers. Goldman Sachs Group Inc. worked with Commerce, as did Sullivan & Cromwell LLP.
Breaking Views, Antony Currie, 2 October 2007

Toronto Dominion Bank is paying a pretty sum to snap up New Jersey-based Commerce Bank. The $8.5bn price tag equates to 22.5 times next year's earnings. That's a quarter higher than the average large bank deal in the last five years, according to Deutsche Bank. And this for a bank that recently had to fire its scandal-tinged founder and chief. Little wonder, then, that shareholders have wiped as much as $3bn off the value of the Canadian bank's value. At the price TD is paying the deal is a risky one, but it has its merits.

Acquiring Commerce extends TD's US presence from the New England franchise it picked up with BankNorth down into New York and New Jersey. Not only is that a coveted banking region, but the proximity of the two should bring significant cost savings --$310m according to TD. Taxed, discounted and put on a multiple of 10, these are worth just over $2bn to shareholders today. That easily covers the $840m premium TD is paying. And it's not all TD can eke out of the deal.

Both banks look overcapitalised - Commerce Bank, with a tier one capital ratio of 11.7%, more so than its new owner. TD could free up some of that, much as Bank of America is doing with LaSalle Bank, which it purchased from ABN Amro.

TD can also improve returns from Commerce's sluggish approach to deploying its deposits. At just 65 basis points, the New Jersey bank's return on assets is among the lowest in the industry. Its loan-to-deposit ratio is just 36% - almost half TD's - while more than half of its assets, or $27bn, are shunted into securities. That's hardly been successful. Indeed, Commerce has taken a few hits when it had to restructure its portfolio after being overwhelmed by yield-curve swings.

Shifting $20bn of Commerce's assets from securities back into more-profitable loans could boost Commerce's earnings by almost a third, according to Deutsche Bank. That could be worth more than $1bn to TD's shareholders. But perhaps the mere thought of all those securities is what has them spooked. After the ructions of the summer, it is understandably hard to get excited about paying up to buy a portfolio of fixed-income securities.
The Globe and Mail, John Partridge, 2 October 2007

Canada's two largest banks announced early Tuesday they are spending almost $11-billion (U.S.) to expand in the United States and the Caribbean, riding on the wings of the soaring Canadian dollar.

With the loonie now at or above par with the greenback for the first time in more than 30 years, No. 2-ranked Toronto-Dominion Bank stole the show by announcing its biggest acquisition to date: a deal to double its U.S. retail banking presence by taking over Commerce Bancorp Inc. for $8.5-billion in cash and stock — a transaction made possible in part by regulatory problems that led to the ouster of the New Jersey bank's founder at the end of July.

The news of TD's planned acquisition overshadowed confirmation from No. 1-ranked Royal Bank of Canada that it is buying Trinidad & Tobago's RBTT Financial Holdings Ltd. for $2.2-billion, in one of the largest recent acquisitions in the Caribbean.

But observers say there is little question that the high-flying loonie will make both deals easier for the acquiring banks to swallow.

“I'm quite sure that had a lot to do with the transactions,” said Neil Andrew, associated portfolio manager at Leeward Hedge Funds in Toronto. “It's certainly very timely.”

“TD has very aggressively taken advantage of the low U.S. dollar, and the valuation discounts that the U.S. financials have been trading on,” analyst John Aiken at Dundee Securities in Toronto told clients in a note, adding in all capital letters for emphasis that he “would not be surprised to see other Canadian financial institutions make large acquisitions in the U.S. in the near term.”

As well, unlike many of their U.S. counterparts, Canadian banks have so far suffered little in the way of collateral damage from the global credit squeeze triggered by the meltdown of the U.S. subprime mortgage market, and analyst Brad Smith at Blackmont Capital in Toronto said it was only a matter of time before they moved to take advantage of the situation.

“The [TD] deal is consistent with our belief that domestic banks would be tempted to use the current credit market disruption to extend their U.S.-centric retail banking strategies,” he said in a note to clients Tuesday.

Based in Cherry Hill, N.J., Commerce Bank has about 2.4 million customers, 460 branches and 700 automated banking machines throughout New Jersey, New York, Connecticut, Delaware, Washington D.C., Virginia, Maryland and Southeast Florida, TD said Tuesday morning. It also has about $48-billion in assets, $44-billion in deposits and 15,000 employees.

“Acquiring Commerce Bank offers a singularly unique and compelling opportunity for our shareholders — one that is both a strategic fit and a superior value creation opportunity through accelerated organic growth,” TD Chief Executive Officer Ed Clark said in a news release, calling the acquisition a “singularly unique and compelling opportunity” for TD shareholders.

“The combination of Commerce with TD Banknorth doubles the scale of our U.S. banking business and accelerates our transformation to a leading North American financial institution.”

Assuming a sweeter competing bid for the U.S. bank does not knock TD out of the game, the deal still must be approved by regulators and Commerce Bank's shareholders.

The proposed acquisition comes about three years after TD broke into U.S. retail banking with the $3.8-billion acquisition of Banknorth Group Inc. of Portland, Me. Since renamed TD Banknorth, it now has more than $40-billion in assets and about 600 branches and 700-plus ABMs in Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, and Vermont. TD also owns 40 per cent of U.S. online brokerage TD Ameritrade.

The Commerce Bancorp deal also comes about two months after CEO Vernon Hill II, a powerful figure in New Jersey business and politics, was forced to step down by the board of directors. This came after he fell afoul of bank regulators for awarding tens of millions of dollars in contracts, including $50-million to his wife to redecorate the bank's branches.

Gerard Cassidy, a U.S. bank analyst in Portland with RBC Capital Markets, said Commerce Bank would not have been sold without Mr. Hill's departure.

“Absolutely not,” he said in a telephone interview. “Vernon Hill was going to be with this bank for a very long time if it wasn't for his untimely exit this past summer when the regulators pushed him out. This man lived and breathed Commerce Bancorp.”

TD said the purchase price for translates to $42 a share for the U.S. bank. Payment will consist of $10.50 in cash and 0.4142 of a TD share for each Commerce Bancorp share.

That's a premium of just 5.7 per cent to the $39.74 at which Commerce Bank's shares closed Monday — up 96 cents or 2.5 per cent — on the New York Stock Exchange, having hit a 52-week high of $39.97 during the session.

However, Mr. Cassidy said a takeover premium has been built into the U.S. bank's shares since shortly Mr. Hill's departure, as analysts and investors speculated it would not remain independent for long. The price has risen to current levels from just over $33 in early August.

He also said the small additional premium in the TD deal reflects the difficult the Canadian bank likely faces in integrating Commerce Bank's operations into those of TD Banknorth, whose own integration has been problematic.

“The integration is going to be difficult because of the culture of Commerce,” he said. “It is a culture of enthusiasm and sales, with the customer always being right. Plus, they provided a level of customer service that was very costly.”

Characterized by such things as seven-day-a-week service, and paying top dollar for the best and most convenient locations, the service level has left Commerce Bank with a level of profitability among the lowest of the top 50 U.S. banks, Mr. Cassidy said.

Still, like Mr. Andrew at Leeward, he agreed the Canadian dollar's strength will help lighten TD's load. “That certainly helps the transaction, there's no doubt about it,” he said.

TD shares, meanwhile, were down $4.11(Canadian) to $72.23 on the Toronto Stock Exchange.

The bank, Canada's second largest by stock market capitalization ($52.7-billion) and assets ($404-billion) said that adding Commerce Bank to its empire would give it a total of more than 2,000 branches in the United States and Canada and approximately one-quarter of a trillion dollars in deposits. This, it added, would make it the seventh-largest bank in North America as measured by branch locations.

Commerce Bank chairman Dennis DiFlorio said in the news release that “joining forces with TD ... opens the door to tremendous new growth opportunities.”

TD Banknorth CEO Bharat Masrani, meanwhile, said the acquisition will “give us scale in the Mid-Atlantic and will allow us to turbo-charge our organize growth strategy.”

TD said Mr. DiFlorio, along with Commerce Bank's new CEO Bob Falese will continue to run the U.S. bank and report to Mr. Masrani.

Assuming it receives all the necessary approvals, TD expects the deal to close next March or April. It said that once the purchase is completed, it will take a one-time restructuring charge of about $490-million (U.S.) before taxes.

TD also indicated that the acquisition will not be profitable immediately, saying it will likely reduce profit by 28 cents a share in fiscal 2008 and by 22 cents in 2009 on the basis of generally accepted accounting principles. On an “adjusted” basis, this will translated into a 10 cent reduction in 2008 and break-even the next year, the bank said.

Commerce Bank, meanwhile, expects to take an after-tax charge of $150-million (U.S.) related to the planned sale of a portion of its fixed-rate investment securities portfolio, which it is undertaking to reduce its exposure to interest rate changes.

It also said it has agreed, following closing, to negotiate the sale of its Commerce Banc Insurance Services Inc. to the unit's chairman and CEO George Norcross III.

Commerce Bank reported a profit of $154.8-million or 79 cents a share on revenue of $1.01-billion in the six months ended June 30. This compared with a year-earlier profit of $156.8-million or 82 cents a share on revenue of $900.8-million.

As for TD, it put $3.16-billion (Canadian) or $4.34 a share on the bottom line – adjusted for unusual items – on revenue of $10.6-billion in the 9 months ended July 31. This compared with $2.5-billion or $3.46 a share on revenue of $9.8-billion in the comparable period of fiscal 2006.