Who will have the guts to take a risk?
Gordon Nixon is sticking to RBC's cautious strategy
STEVE MAICH | September 17, 2008 |
Right now, all across the United States, small and mid-sized banks (not to mention a few giants) are in a desperate fight for their lives. They bit off huge mouthfuls of shaky mortgage debt over the past seven years, and now they're choking on it. They are in urgent need of a lifeline, but there are precious few in a position to provide the billions of dollars in capital needed to shore up their crumbling balance sheets. The very short list of potential saviours includes foreign sovereign wealth funds, private equity firms, and our very own major banks — RBC, BMO and TD chief among them.
The big rarely mentioned truth of the current financial meltdown in the U.S. is that it may provide the single greatest opportunity for growth that our banks have ever seen. Maybe not this week or next, but within the coming year, they will have a golden chance to finally become significant players in the world's biggest and most dynamic market for financial services. The only real question is whether they will grab it or let it pass. It sounds like a no-brainer, but it isn't. And to understand why, you need to know a bit about who calls the shots on Bay Street.
For more than two decades, BMO, Royal and TD have been slowly, carefully expanding their U.S. presence. Royal concentrated on snapping up little banks in the Southeast; TD in the Northeast, and BMO in the Midwest. Scotiabank has instead focused on the developing world, while CIBC's U.S. expansion revolved around the brokerage business and is now essentially dead.
But for RBC, BMO and TD, caution remains the guiding principle for a host of reasons. The U.S. market is extremely competitive and fragmented, and valuations have traditionally been sky-high. When the Canadian dollar was languishing around US70 cents, it was all but impossible to find affordable takeover targets, even when the Big Five were reeling in record profits.
Now, everything has changed. The loonie is close to par, and thanks to a rash of mortgage defaults and tightening credit conditions, U.S. bank stocks have plunged. Canadian stocks have slipped back too, but their troubles are a walk in the park compared to their American cousins. The relative strength of our domestic market — thanks to surging commodity prices and resilient real estate — has created this historic opportunity. Canadian banks have plenty of capital, relatively high stock prices, comparatively stable earnings. When you're a banker, this is what the view from the catbird seat looks like.
There are bargains everywhere. Consider that when TD bought New Jersey-based Commerce Bank late last year, it paid 2Â½ times its book value. (Book value is essentially the present value of all assets minus the present value of all liabilities, and gives you an idea of how much money would be left, after paying off debts, if you wrapped up a business immediately.) That was considered a reasonable price, but now dozens of U.S. regional banks are trading for less than their book value — in some cases less than the value of the cash they have on hand. BankAtlantic, for example, had a book value of US$7.27 per share as of June 30, and was trading last week for US$1.80. Philadelphia-based Sovereign Bancorp, which has been desperately trying to simplify its business, had a book value on June 30 of US$12.43 a share. Its shares were selling last week for just US$8.76.
Still, caution rules the day. The prominent Wall Street brokerage Lehman Bros. declared bankruptcy this week, and is now liquidating hundreds of billions in assets. RBC reportedly kicked the tires earlier this summer, but backed away. RBC chief executive Gord Nixon perfectly summarized the philosophy of all Canadian banks recently when he said, "we are not in a rush and we are not interested in making a deal that fails to satisfy our strategic, financial and cultural criteria." That's prudent and reasonable, of course. Book value is nothing but an estimate — a shaky one at that, especially when banks are having to write off huge loan portfolios on a monthly basis. Buying Lehman in the middle of the storm may well have been a huge mistake. But if Canada's banks are ever going to truly become global champions in the world of high finance, sticking dogmatically to "cultural criteria" isn't going to get it done.
There are many who say that Canada's bank CEOs simply lack the moxie and the smarts to really compete down south. But it's not really the CEOs who are the problem so much as the people who pull their strings — the mutual fund managers and pension boards who hold the lion's share of every bank's stock. As one well-connected Bay Street observer told me this week, "they all say they're long-term thinkers, but they're not. They all have stories about Canadian companies that have gone to the U.S. and got killed." These investors provide the capital that is the lifeblood of any bank. To them, the banks are the foundation upon which their portfolios are built. They love their stability, their predictability and their steady flow of dividends. The last thing they want is RBC or TD or BMO taking a big risk that might drive down the stock and hurt their next set of quarterly results.