Tue. Jan 18th, 2022

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Dear reader,

Greetings from New York, where the weather is a whopping minus 8 degrees Celsius (even lower with any wind-chilling factor). After an exceptionally soft start to the winter season, an Arctic freezing point arrived this week with a whiplash via Canada.

This icy explosion is not the only intruder north of the border. Canadian banks – flushing with excess capital and record share prices – have also poured in, trying to expand their presence in the US.

Bank of Montreal (BMO) made headlines last month when it entered into an agreement to buy the US unit of BNP Paribas for $ 16.3 billion. The deal, one of the largest ever by a Canadian lender, is a risky bet. BMO already has a significant presence in the Midwest following the acquisition of Harris Bankcorp in the 1980s and the acquisition of Marshall & Ilsley a decade ago.

But the acquisition of the San Francisco-based Bank of the West will double its U.S. retail presence and give it a strong position in California, which was economically resilient during the pandemic.

The current pressure comes at a time of relative strength. Once named the world’s best boring bank, Canada’s largest lenders are more lucrative than ever before, thanks to years of low interest rates, robust consumer loans and a red-hot housing market fueling mortgage demand.

Chart showing share prices of Canadian banks

The “Big Six” – Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia (Scotiabank), BMO, Canadian Imperial Bank of Commerce and National Bank of Canada – combined to withdraw C $ 57.7bn (US $ 46bn) net profits in the financial year ended in October. Return on equity at the banks ranged between 14.4 percent and nearly 21 percent, above the range for America’s largest institutions.

It should come as no surprise that Canadians went shopping in the south. High capital levels have piled up during a nearly two-year moratorium on capital redistribution – which was only lifted in November – and share prices trading at record highs indicated that Canadian banks would seek acquisitions.

The US has an attractive market. Unlike Canada, where the Big Six already controls nearly 90 percent of the market, the US has a more fragmented industry and offers more opportunities to grow.

And compared to European banks, Canadian lenders have proven better at making money in the US market. This explains why BBVA withdrew from Spain, NatWest and even HSBC from the US. They have struggled to compete against major Main Street lenders such as JPMorgan Chase, Bank of America and Wells Fargo.

At BMO, the U.S. unit’s return on equity was 15.8 percent in fiscal 2021 and did a good job of controlling overhead. Its adjusted efficiency ratio, which measures expenditure as a percentage of revenue, clocked at 50.8 percent. Bank of the West is doing less well at 63 percent, suggesting BMO will target that higher cost base to generate a $ 860m target in pre-tax cost synergies from technology and back-office savings.

Apart from BMO, TD Bank also has a large presence in the US. Canada’s second largest lender by market value has become the eighth largest in the US in terms of assets. After apparently losing to BMO at Bank of West, he remains eager with a strong balance sheet to support his appetite.

Meanwhile, RBC, Canada’s largest bank, is interested in buying wealth distribution and commercial banking businesses in the US.

One downside for shareholders on any major transactions would be on stock buybacks or dividend increase plans. This will probably have to stand still. BMO has already said it will postpone its share buyback program, which it previously promised to restart, until the Bank of the West deal closes.

But investors need to be patient. So far, Canadian banks have hit above their weights in the US. Greater scale efficiency that comes from consolidation will help them retain their places.

Nice rest of the week.

Pan Kwan Yuk
Lex author

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