U.S. offers growth potential for banks

Executives at the Big Five banks appear to agree that maintaining the high rates of earnings growth that they’ve achieved domestically over the past several years will be a challenge in 2013 and beyond if the domestic economy struggles as much as some economists predict. All banks will be looking for earnings growth in business lines outside their core domestic banking operations, and in other regions, such as the U.S.

“I don’t know why the Canadian financial services industry ought to grow [at rates] that much faster than nominal [gross national product],” said Ed Clark, president and CEO of Toronto-Dominion Bank, at a banking conference in early January. “And, theoretically, it’s even possible that it can grow less, if [Canadians] start to deleverage.”

In contrast to Canada, the U.S. may finally be poised for a more robust recovery in 2013 after almost six years of slogging through an economic downturn.

“Without question, our U.S. [banking] entity will grow faster than TD Canada Trust this year,” said Clark. TD’s U.S. personal and commercial (P&C) banking unit posted adjusted net income of US$358 million in the quarter ended Oct. 31, 2012, up by 23% vs the corresponding period in the year prior. Canadian P&C banking earned $831 million in the same period, up by 10% year-over-year.

Although just two of the Big Five banks – TD and Bank of Montreal (BMO) – have significant retail operations in the U.S., all are interested in growing business in the U.S., whether their capital markets units, wealth-management lines or other operations.

“European banks, by virtue of trying to protect and rebuild capital at home, are lending less into the U.S.,” Sedran says. “So, there’s market share to be gained in the wholesale side of the business. I think opportunity exists on the wealth-management side as well.”

John MacKinlay, national financial services consulting and deals leader with PricewaterhouseCoopers LLP in Toronto, suggests that there continues to be opportunities in the U.S. for Canadian banks to grow by acquisition, although the number of suitable targets may be fewer than what was available during the worst of the financial crisis.

“There’s a surprising number of reasonably sized, mid-tier banks – with US$5 billion to US$15 billion, maybe even US$20 billion, in assets – that could move the needle [in terms of being suitable acquisition targets],” says MacKinlay. “The question is: are those ones going to appear as opportunities over the next few years? I’m sure some of them will.”

Recently, analyst reports have suggested that Providence, R.I.-based Citizens Bank, the U.S. retail arm of Royal Bank of Scotland (RBS), could be up for sale; RBS faces pressure from its majority owner, the British government, to raise cash. Some banking analysts have speculated that TD could be a possible acquirer of Citizens Bank, the purchase price of which would be in the US$12 billion-US$16 billion range.

Without naming the bank involved, Clark, speaking at the January banking conference, attempted to throw cold water on this rumour: “We don’t need to buy this, and we wouldn’t do a deal that was stupid.”

Gavin Graham, president of Toronto-based consultancy firm Graham Investment Strategy Ltd., says that it’s highly likely that TD would at least consider the acquisition if the unit comes into play: “Citizens Bank is a big bite, but it’s one TD could do. There’s no reason to think that TD wouldn’t be in the market to continue to build up its U.S. presence – because that’s the strategic bet it has made.”

In October, TD announced the acquisition of the U.S. Visa and private-label credit card portfolio of retailer Target Corp. In December, TD pulled the trigger on the purchase of New York-based asset manager Epoch Investments Partners Inc., which manages about US$24 billion in assets, including several funds for Toronto-based CI Investments Inc.

“[Epoch is] on strategy for TD,” Sedran says. “It wanted a U.S. equity capability to continue to build out its North American wealth-management platform.”

@page_break@TD has indicated it intends to take a hands-off approach with Epoch. Said Clark: “The critical issue always, when you do these kinds of acquisitions, is: don’t mess it up. Leave it alone. Let them keep doing what they’re doing and we can make a lot of money off of this by feeding them business.”

The other big Canadian player in the U.S. retail market, BMO, has not been as successful as TD has been in creating a U.S. franchise of sufficient scale, but BMO’s recent integration of Marshall & Ilsley Corp. (M&I) – which BMO acquired in 2011 after M&I, a Milwaukee-based bank, ran into trouble managing its loan book – into its existing Chicago-based BMO Harris unit has received positive reviews.

“M&I was a great deal,” Graham says. “BMO has always been conservative about the [loan-loss] provisions it takes when it makes acquisitions. Over the past year or so, [BMO] has been able to write back some of those provisions into its bottom line, which has certainly helped [the earnings results].”

Sedran believes that BMO may now have the scale to be able to achieve more meaningful results from its U.S. retail unit: “[BMO Harris] needs better asset growth, better revenue, better expense control – better everything – to begin to provide the incremental growth levers that [BMO] always hoped for from its U.S. bank.”

Speaking at the same January banking conference, Bill Downe, BMO’s president and CEO, said that his bank is finding more and better ways to integrate its U.S. operations with the Canadian operations in order to achieve efficiencies, lower costs and provide integrated services to clients who do business on both sides of the border.

“We’ve gone from having a 300-branch network in the U.S. [with BMO Harris],” Downe said, “which I don’t think had sufficient scale to be really efficient, and a 900-branch system in Canada to having 1,600 branches.”

Downe also acknowledges that there has been “a fundamental slowdown in the formation of consumer debt in Canada,” and that BMO’s U.S. operations will provide an opportunity to achieve stronger earnings in a resurgent U.S. economy: “The bank is perfectly positioned for a recovery in homebuilding, consumer debt picking back up to more normalized levels and, particularly, to commercial loan growth in the [US] Midwest, which is very strong.”

In fact, Downe believes that 2013 may be an inflection point for the U.S.’s stubbornly sluggish real estate market: “I think, this spring, the revival in the U.S. housing market is going to be surprising.”

BMO will be emphasizing organic growth – opening new branches or making small, “tuck-in” acquisitions – rather than making a significant banking acquisition, Downe said, suggesting that the regulatory environment in the U.S. remains uncertain and volatile. “The opportunity,” he said, “to do a large acquisition in the U.S. in the [current] political environment is very low.”

But BMO would be interested in considering acquisitions in the U.S. wealth-management space, Downe added: “We now have a global sales force for [the asset-management] business, and the U.S. private bank is much larger and very profitable. So, I think there are opportunities to do wealth-management acquisitions that would be complementary over time.”

Of course, TD and BMO are not alone in their interest in boosting their U.S.-based lines of business. Canadian Imperial Bank of Commerce (CIBC) has identified U.S. wealth-management and capital markets as two areas in which it would like to grow. In 2011, CIBC bought a minority stake in Kansas City-based asset manager American Century Investments Inc. for US$848 million. Last year, CIBC purchased Griffis & Small LLC, a Houston-based energy advisory firm.

Royal Bank of Canada (RBC) left the U.S. P&C market in 2011, when it sold RBC Bank to PNC Financial Services for US$3.6 billion, having failed to achieve the scale required to transform the U.S. unit into a success.

However, RBC continues to invest in its global capital-markets and wealth-management arms, including those in the U.S.

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