Three of canada’s biggest banks are slowly but steadily building their U.S. retail bank subsidiaries as they try to stake out a claim in the world’s largest and most competitive banking environment. Yet, some observers contend, the south-ward expansion may be too slow.

Federal permission for domestic bank mergers is still being withheld, so Canada’s Big Five banks have grown in recent years by acquiring and developing international businesses.

The significant U.S. retail franchises of Canadian banks are:

> TD Banknorth Inc. , acquired two years ago by TD Bank Financial Group, has US$40 billion in assets and about 600 branches in eight U.S. northeastern states. Its headquarters are in Portland, Me.;

> RBC Centura, wholly owned by RBC Financial Group since 2001, is based in Raleigh, N.C., and has 338 branches in the U.S. southeast. RBC doesn’t break out financial results for the unit, but its wider U.S. and international personal and business group held slightly less than US$36 billion in assets as the year began;

> Harris Bank, bought by Bank of Montreal in the mid-1980s, now has 233 branches in Illinois and Indiana and US$40.6 billion in assets.

Neither CIBC nor Bank of Nova Scotia, the latter of which has extensive business in the Caribbean and Latin America, owns a U.S. retail bank subsidiary.

Canadian banks have been careful in building their U.S. franchises. Each of the three has made modest “bolt-on” acquisitions in the past year or so, buying smaller banks as the opportunities arise and folding them into the larger organization. None has made a big purchase.

Although the caution is understandable, Chris Lowe, senior vice president and portfolio manager with Burlington, Ont.-based AIC Ltd., suggests the banks run the danger of being outmanoeuvred by local competitors. He isn’t alone.

“I’m a little surprised that when the Canadian dollar got to US90¢, we didn’t get some further deals,” says Richard Nield, a portfolio manager with Toronto-based AIM Funds Management Inc. in Austin, Tex. “I think there was an opportunity there. Either of the three [Canadian banks with U.S. operations] could have made some acquisitions and spent some of the cash on their balance sheets.”

Bank executives contend that there aren’t many affordable acquisition targets in the U.S. right now, and they don’t want to overpay for growth. As well, Canadian bank shareholders, accustomed to fat profits and steady dividends, tend to punish the banks’ stock when they feel it has overreached.

“If RBC announced some US$5-billion acquisition, I think the stock would take a big hit,” Nield says. “The safer way is to make these small bolt-on acquisitions, so that the market is less likely to notice.”

Other observers agree that the “go slow” approach has merit.

“To say a bank is overly cautious in making acquisitions always presupposes the deal it wants to make will be a good one,” says Jason Bilodeau, a bank analyst with Toronto-based UBS Securities Canada Inc. “Everybody is quick to go the other way when the acquisition doesn’t work out.”

BMO and RBC say they are still on the lookout for acquisition targets, but TD plans to take a pause in its expansion strategy in 2007 as it looks to strengthen its core business after several years of expansion.

The U.S. banking market, insiders and observers agree, is significantly different from Canada’s. Canada has a handful of dominant banks, among a group that totals no more than a few dozen; there are between 8,000 and 9,000 U.S. banks, most of which are regional and highly competitive. And, as a group, U.S. consumers are very sensitive to price and customer service, displaying distinct buying and behaviour patterns compared with Canadian banking customers.

In addition, the U.S. economy has been tough for banks in the past few years. An inverted yield curve has squeezed margins, and there are worries over a slowing U.S. economy, deteriorating credit quality and the spectre of a continued drop in the real estate market.

Of the three U.S. subsidiaries, TD Banknorth had a particularly tough 2006 as it felt the pressure from competition and the economy.

“Clearly, the U.S. banking environment is more hostile than we thought it was going to be when we went in,” TD Bank’s president and CEO, Ed Clark, told a conference in January.

Last fall, TD Bank struck a deal to purchase the remaining 43% of TD Banknorth it didn’t already own. It then sent bank veteran Bharat Masrani to run the subsidiary, replacing CEO Bill Ryan, who remains chairman.

@page_break@The trick for TD Bank will be to bring its Canadian retail banking expertise to its subsidiary, while being sensitive to the different realities of the market in the U.S. northeast, observers say.

“I think you need a strong management team out of the U.S.,” says Nield. “TD Bank’s management team came to the conclusion that they needed to be more hands-on. It’s a fine balance.”

Instead of expanding, Clark has said, TD Banknorth will look to pursue a strategy of finding better locations for branches, instilling a performance culture at its branches and offering customers a wider array of products to retain customer business over the next two or three years.

The recent problems with TD Banknorth are mitigated somewhat by the solid performance of TD Ameritrade, a U.S. discount-brokerage subsidiary in which TD Bank has a 40% stake.

In the case of RBC, that bank has taken a very cautious approach to building RBC Centura, following several miscues made shortly after the acquisition.

“RBC tried to imprint its approach on the Centura model, in terms of perhaps more strict risk controls and processes, that were inconsistent with the way Centura had been doing business traditionally,” Bilodeau says. “That did not meet with good success.”

RBC decided more than a year ago to hold off on major expansion and get RBC Centura back on track. It made two small acquisitions in 2006, buying the 17-branch Georgia-based Flag Financial Corp. and 38 branches in Alabama from AmSouth Bank. It also opened 10 new RBC Centura branches.

RBC Centura targets a niche of “businesses, business owners and professionals” and has been slowly transforming itself into a bank with more branches in urban areas. RBC says it plans to open 12 to 16 new RBC Centura branches in 2007.

Nield says RBC Centura does not currently represent a high-growth entity for RBC, since it yields a return on equity of roughly 10%, well off the Canadian retail bank average ROE of more than 20%.

“RBC is in a bit of quandary because if it doesn’t make any more acquisitions, you’re really just left with a 10% ROE bank with not a lot of growth,” Nield says. “On the other hand, if it does make an acquisition, the market will probably penalize the stock because RBC does not have a good track record of making good U.S. acquisitions.”

BMO, meanwhile, has a long history in the U.S. retail banking sector through Harris Bank, which is a dominant player in Chicago and the surrounding area. Harris Bank intends to continue to open new branches in the city and spread through the Midwest by acquisition.

In July, BMO made a number of management changes, including appointing Ellen Costello, former head of BMO Capital Markets, as CEO of Harris Bank, replacing Frank Techar, who moved back to Toronto to head BMO’s Canadian retail business. In September, BMO announced that Harris Bank had purchased 32-branch, Indianapolis-based First National Bank & Trust, extending Harris’s reach into Indiana.

Some bank analysts say BMO enjoyed a competitive advantage in Chicago in years past, but did not press its advantage by making acquisitions. Today, there are more than 300 banks in the Chicago area, which has seen hundreds of branches open in the past several years.

“Time and time again, BMO has been so conservative and not wanting to make a mistake,” Nield says. “Arguably, this business should be a lot bigger than it is.”

Adds Lowe: “What it had, and the opportunity it had, was great. And it still is attractive. But, boy, what a shame, because it could have been so much more.”

Some analysts say that current chief operating officer Bill Downe, who replaces Tony Comper as BMO’s CEO in March, will place a stronger focus on building the U.S. retail business. In 2002, Downe was given responsibility for all BMO’s U.S. operations while continuing his duties in several other senior roles.

“I would think, just given his background, Downe would probably be looking at making some acquisitions bigger than what Harris has done historically,” says Nield. IE