From the October 2006 issue of Investment Advisor • Subscribe!

October 1, 2006

Southern Exposure

There's only one place for the big Canadian banks to go--down. To the lower 48 states, that is

The Canadians are coming, the Canadians are coming!

Spurred by a strong currency and a mature domestic market lacking in significant growth opportunities, some of Canada's most powerful financial services companies have bulked up with recent acquisitions south of the border. They are not likely to be alone as some of their deep-pocketed competitors are making no bones about following suit when the right deal--or more likely, deals--comes along.

In mid-August, the country's largest bank, Royal Bank of Canada, purchased Atlanta-based Flag Financial Corp. for $456 million U.S. The deal adds 370 employees to the payroll at North Carolina-based RBC Centura, as well as 17 branches and relationships with about 22,000 client households. Its deposit balances increased by about $1.35 billion, or 12%, and its loans portfolio jumped by $1.25 billion, or 10%. Just as importantly, the Flag purchase represents RBC Centura's first acquisition since 2003 and appears to signal renewed confidence in the U.S. market.

Scott Custer, the bank's president, says the U.S. is clearly a place where it wants to grow.

"The southeast is a great market," he observes. Custer says RBC already has a significant market share in Canada and as it looks for places to expand, it's only natural to look across the 49th parallel. "The Canadian market is wonderful. It's just that the U.S. offers great growth opportunities," he explains.

Six weeks earlier before RBC's announcement, Canada's largest insurance company, Great-West Lifeco, acquired the pension plan business from New York-based Metropolitan Life and a pair of its American subsidiaries.

The deal's purchase price wasn't revealed but Lifeco CEO Ray McFeetors says it adds more than 2,600 plans, roughly 300,000 clients, and 225 people, including 80 "relationship managers," to the fold.

He says it will add $7.5 billion in assets to its Denver-based subsidiary, Great-West Life & Annuity Insurance Co. He says this is anything but a one-off deal. It's part of well thought out strategy to grow organically and through acquisitions in both the U.S. and the U.K.

"The place where we have a big need is in the U.S. market," McFeetors says. "We're working on other (acquisitions) all the time. We think there are a lot of opportunities in the U.S. and U.K.," he said.

Dan Richards, president of Strategic Imperatives, a Toronto-based consulting firm to Canada's financial services industry, says it's only logical for companies with aspirations of being substantial players beyond their own borders to expand in the U.S.

He says that Canada's so-called "Big Five" banks--CIBC, RBC Royal Bank, BMO Bank of Montreal, TD Bank, and Scotiabank--are "banging it out" in a relatively slow growth environment in Canada and their desire to merge with each other, a political hot potato that has been on and off the table for nearly a decade, is currently in governmental limbo.

"You've got strong players that are reaching the limits of their growth potential in their home market," he says.

But Richards notes Canadian executives won't be walking around with blank checks as they look to add to their U.S. holdings. He says a profitable business case must be made for all potential acquisitions. "There's a long list of foreign players who have been successful in their home markets, gone to the U.S. and had their heads handed to them on a plate," he says.

Dan Hallett, an industry analyst based in Windsor, Ontario, agrees with Richards. He says the Big Five in particular are so strong in Canada that they have to either look to the U.S. or stagnate. Even with the Canadian dollar having risen about 30% against the U.S. greenback over the last three years or so, most U.S. financial institutions aren't screaming bargains but they have enjoyed a "pretty strong" market in terms of stock prices and fundamentals.

"Generally, there are some good opportunities in the U.S. Valuations are pretty reasonable, certainly more so than they used to be. U.S. companies traditionally were trading at a premium, in part because there were so many big multi-national companies in a bigger market. The last few years have really been a unique environment historically where the Canadian market has become expensive," he says. Hallett says the U.S. market fell "pretty hard" in the aftermath of the tech bubble bursting, but what has surprised more than a few industry watchers is how slow it's been to recover.

"The swings tend to be a little wider in both directions. That hasn't happened here. A lot of the companies are very strong but the valuations haven't reflected the past five or six years of continued profitability and cash flow generation. If you incorporate currency into that, [the U.S. market] really hasn't done anything," he says.

Paul Bates, former CEO of Charles Schwab Canada, has a different take on the situation. He says the U.S. financial services sector is desirable because it's highly diversified and isn't dominated by a small number of players as Canada's market is. Making American companies even more attractive is the fact the accounting and regulatory systems in both countries are very close, many of the same securities are traded on both sides of the border and the U.S. market is very well known to Canadian firms and investors alike.

"There are literally thousands of banking institutions in the U.S. and a multiple of that in investment firms. They range from brokerage firms to niche specialists that deal in municipal bond offerings, for example. If you want to do a deal in Boca Raton, there's probably a deal to be done with an independent company there," he says.

Bates says any time a foreign player increases its presence in a particular market, opportunities usually follow quickly behind. For example, he says U.S. advisors working at the acquisition targets of Canadian firms should have greater access to securities markets north of the border once a deal is consummated.

For some advisors already thinking about making a change, new ownership, particularly foreign ownership, can often be the trigger to move elsewhere and Bates' advice is to "hold your horses."

"There may be opportunities you haven't perceived yet. Heft of any kind usually brings greater job security and new opportunities," he says.

Richards concurs. He says from an advisor's perspective, the more players in the market, the better."There's more competition for advisors and more places for them to go," he says.

Bill Downe the newly-appointed chief operating officer at BMO Financial Group says it has capital at the ready to do deals worth up to $2 billion. Its U.S. operations are anchored by Chicago-based Harris Bankcorp. Inc., which opened its 200th branch this past May in West Lincoln Park, one of the fastest-growing communities within the Chicagoland metropolitan market.

"There are lots of acquisition opportunities in the $50-million to $100-million range and in the $250-million to $500-million range. If we could buy a larger company that meets our criteria, we'd do it," he says.

Those requirements include having a similar business model in terms of high customer service and relationship-based banking, as well as management with the same type of vision for building the business in the future.

"We know how to operate across five time zones and we have the confidence to run a bank branch system. Our focus at Harris on customer service allows us to compete in a sector typically occupied by independent community banks," he says. Harris's next goal is to add 20 more branches in the area by 2007 and grow to 350 to 400 branches across the Midwest within the next five years.

Downe says bank's focal point for growth is in the U.S. Midwest, in large part because its culture is very similar to Canada's. "The relationships with customers, the way we think about the communities we're in, the employees' work ethic and the commitment to customers is essentially the same," he says. One-quarter of the bank's business is currently in the U.S. but Downe expects that proportion to grow because "we won't be bumping into ourselves" in the largely unconsolidated U.S. market.

Canadian institutions aren't alone in their quest to pick up desirable players in the U.S. Capital One Bank, JP Morgan & Co. and Wachovia Corp. have added hundreds of new branches and billions of dollars of assets through acquisitions this year.

And you don't have to be a behemoth to get into the acquisition game either. Less than a year ago, Winnipeg-based Wellington West Capital bought 50% of One Capital Management, an investment firm in Los Angeles with $450 million in assets under management. Charlie Spiring, CEO of Wellington West, which has about $6 billion in assets, says after branching out across Canada during the last six or seven years--it has more than 20 offices from coast to coast--the U.S. is the next frontier. The opportunity in California is as big as the opportunity in Canada," he says.

Other regions of the country are similarly lucrative in the eyes of some Canadian firms. In April, TD Banknorth announced it had acquired Interchange Financial Services Corp. for $480.6 million. A year ago, Banknorth bought Hudson United for $1.9 billion, a move that added 590 branches, 751 ATMs and more than $26 billion in deposits across eight northeastern states.

Ed Clark, president and CEO of TD Bank, says the goal for its TD Ameritrade division is to be a top three player in the U.S. online brokerage business. He says combined with TD Waterhouse, it has significant strength in both the long-term investor and active trader space and that two-pronged approach gives it the best U.S. platform among Canadian banks.

"You can't build a credible North American financial institution without a strong U.S. retail presence. We want to have sustainable positions in each of the markets in the northeastern United States where we choose to compete," he says.

RBC Centura's Custer has a similar philosophy and isn't as concerned with the size of potential acquisitions as he is with their fit. "For us, selective acquisitions and opportunities for growth have to fit with our operating model and strategy in the right market," he says. "We don't just look for a bank with a 'for sale' sign on it. We try to find those companies that have a complementary culture," he says, noting its banking, capital markets, and wealth management divisions have their own individual business strategies for expansion.

Unlike BMO, RBC hasn't said what it would consider spending for the right acquisition. "You don't grow yourself to greatness," Custer says. "A small company may fit a niche you want to fill. We're going to be very selective, very patient, and very measured in how we [grow in the U.S.]," he says.

That was evident in July when RBC Centura announced plans to open 12 branches in high-growth markets in Georgia, primarily in the Atlanta area, and in south Florida, by the end of the summer. Another 10 are on tap for next year. With $21 billion in assets and nearly 300 branches in the U.S., the majority of which are in North Carolina, RBC Centura is the 50th largest bank in the U.S., according to a 2005 study by the Federal Reserve.

Great-West Lifeco's McFeetors is a big believer in the idea that success begets success when it comes to building a North American powerhouse. He says the fact Lifeco was the winner in a very competitive bidding process for the MetLife business will significantly increase its profile in the U.S.

He says it's unlikely Lifeco will be able to duplicate its success in Canada--where it is the largest provider of insurance products, touching one in three Canadians--south of the border. The U.S., however, is a market where he feels the company can grow in two critical segments: the lucrative 401(k) retirement and healthcare businesses.

"We don't think we're at the most efficient size or most sustainable size (in the U.S.) yet. You need to add scale to continue to improve your expenses. In financial services, we're much better positioned. We're currently looking at a number of deals in the healthcare space. We'd like to conclude on those," McFeetors says, noting that he believes the sweet spot in financial markets, not only in the United States but in Canada and Europe as well, is the asset accumulation business, primarily related to pension plans. "It's the area where the population has wealth and needs to invest it for retirement."

According to McFeetors, Lifeco has a history of using independent advisors to sell and service 401(k) plans. "That's how we sell the 401(k) business. We have wholesalers who are employed by us and they interface with the independent brokers who sell and service the plans," he says. "The great flexibility of our processing system allows us to easily add new investment options and it allows plan participants to easily manage their investments and make changes. We believe we can deliver a much better package to individual plan participants and to employers offering 401(k) plans."

Bob Wuelfing, president of RG Wuelfing & Associates, a Connecticut-based market research and consulting firm, says Lifeco "absolutely" has the potential to be a top five player in the trillion-dollar U.S. 401(k) marketplace. He says despite Great-West beating the bushes for deals in the U.K., the American market represents the company's greatest opportunity.

"I would think Great-West Lifeco increasing its market share in the U.S. by one per cent would be more valuable than anything it could do in the U.K. The retirement dollars are here. The U.S. market will probably see more change in the next five to seven years than it's seen in the past 15 or 20 years," he says.

Geoff Kirbyson is a business reporter and personal finance columnist for the Winnipeg Free Press, an IA contributing editor, and a freelance business writer. He can be reached at gmkirbyson@shaw.ca.

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