Canadian Banks in the U.S.: What's Next?

By Andrew Willis

For three Canadian bank CEOs, one strategic issue dominates all others: How to fix U.S. retail banking divisions that simply aren’t pulling their weight.

Toronto-Dominion Bank (TD), Bank of Montreal (BMO) and Royal Bank of Canada (RY) have all amassed substantial U.S. branch networks, and none of these units are kicking off acceptable returns. TD Bank can at least point out that it’s making money south of the border - over the past nine months, the unit turned a $280 million profit.

In contrast, Royal Bank branches in the southeastern U.S. lost $346 million and the Bank of Montreal network in what’s known as Chicagoland lost $70 million. All three U.S. units are far less effecient than the retail operations of their larger Canadian parents, partly because they lack the scale of national branch networks. Now, we’re in the teeth of a brutal U.S. recession, one that’s been particularly hard on banks, so weak returns are to be expected.

But for the bank CEOs and the boards, it’s a subject of some concern when a division doesn’t turn out the double-digit return on equity that Canadian bank shareholders have come to expect. What makes this problem more pressing is that none of these units seem capable of posting this kind of profitability in the foreseeable future.

So what’s a bank CEO to do?

Well, executives who need advice should look no further that BMO Nesbitt Burns’ research department, where analysts John Reucassel and the redoubtable Hugh Brown weighed with a report this week on the Canadian banks’ excellent adventure in U.S. retail banking.

“The current environment highlights the operating challenges faced by the Canadian banks. Specifically, even when loan losses return to ‘normal’ levels, generating adequate returns on investments remains elusive,” said the BMO Nesbitt Burns team.

“The final solution to their under-scaled operations is to buy or sell (sell outright or partner with a larger player),” said the two analysts, advice that is easy to give, but a little harder to execute.

Polishing up their crystal balls, Mr. Reucassel and Mr. Brown said: “The inability to generate sufficient returns could cause Bank of Montreal, TD Bank and Royal Bank to evaluate strategic alternatives. Royal Bank and Bank of Montreal may consider a partnering strategy while TD Bank may be more inclined to grow its business in the U.S.”

However, these two banking experts expect the deals will only play out when the economy is clearly in recovery mode.

Despite strong balance sheets, Mr. Reucassel and Mr. Brown said the Canadian banks are unlikely to do major acquisitions in an environment that features a great deal of uncertainty when it comes to credit, and the balance sheets of target banks. The two analysts did say that Canadian banks could end up buying distressed U.S. institutions, if the purchase was supported by U.S. regulators such as the Federal Deposit Insurance Corp.

Comments

[derryl:]

After the bubble and bust the US is in a Japan-style balance sheet recession. The weakest must be allowed to fail. For the salvageable US private sector, including banks, to repair their balance sheets would take 7-15 years of devoting profits and incomes to debt paydown. If this is to work without the US suffering a Depression level collapse of GDP, the government will have to become borrower-and-spender of last resort, as Japan has done. US public debt will grow scary high.

Prieur du Plessis has linked to a talk Richard Koo gave on this subject. Koo is the only person I have seen who thoroughly understands the macroeconomics of a fiat money system and its interactions with a nation's financial system and real economy.

seekingalpha.com/artic...

How does this bode for Cdn banks in the US? Real estate has a long way to go down still so generally speaking mortgages will be losers. In a period of post-bubble balance sheet repair the credit that inflated bubbles is being paid out, and the reduced money supply cannot support the inflated asset prices, so asset prices have to come down. So far the US has been applying monetary and fiscal policy to try to reflate the bubble valuations, and they have succeeded to a great extent to quell the panic and support the banking system. But over the medium term as banks recapitalize out of profits these asset values will be allowed to come down.

There are still creditworthy borrowers and viable businesses in the US. Citi is going down and Citi serves 1 million small-medium businesses. There should be some opportunities in areas like this. I have heard lots of Americans, who say they are creditworthy, complaining that banks won't lend. Many banks are technically insolvent and are in a process of recapitalizing, deleveraging and reducing their balance sheets, so of course these banks are not interested in making new balance sheet expanding loans. Solvent bankers, both American and Cdn, should be able to fill this void.

If the US plays its cards right it could follow Japan's example and pay its way out of debt, over the course of a decade or so. The US$ would stabilize and GDP could be maintained by ongoing fiscal stimulus. There need be neither deflation nor inflation.

If the Fed and government refuse to accept a decade of no growth, and insist on supporting asset values at inflated levels in a vain effort to rekindle the overindebted economy, then ongoing QE will be necessary and the US$ will continue its decline and the US will have inflation with no growth--stagflation. If the US tries to remove the monetary and fiscal supports there will be deflation, GDP contraction, widespread private sector bankruptcies and bank failures, and a severe Depression.

Nov 12 09:32 PM