Canadian Banks Should Target Growth Across the Border

05/14/09 - 01:04 PM EDT

RY , TD , BMO , RM , BNS , PNC , FITB

Canadian banks pride themselves on having mostly sidestepped the global downturn that has ensnared almost every U.S. financial firm, and their conservatism has been admirable. Now it's time for them to take advantage of their relative strength and gobble up some weaker players to the south.

The "Big Five" Canadian banks -- Royal Bank of Canada (RY Quote), Toronto-Dominion Bank(TD Quote), Bank of Montreal(BMO Quote), Canadian Imperial Bank of Commerce(CM Quote) and Bank of Nova Scotia (BNS Quote) -- are doing better than Bank of America(BAC Quote), Citigroup(C Quote) and various U.S. regional banks since the storm clouds formed in August 2007.

The stocks of these Canadian banks are down between 30% to 44% since then, compared with declines of 80% to 95% for the U.S. banks. The one U.S. bank which has notably outperformed the Canadian banks is JPMorgan Chase(JPM Quote), which is only down 22% since August 2007.

The Canadian banks need to decide how they are going to take advantage of their relative health on the global stage to serve their shareholders. All five of these banks have traditionally stayed focused on their home market. That seems laudable when you look at the wreckage of banks like the U.K.'s Royal Bank of Scotland(RBS Quote), Switzerland's UBS(UBS Quote) and Australia's Macquarie Group.

Bank of Nova Scotia, or Scotiabank, has experimented a little with expansion into Mexico and Latin America. Royal Bank of Canada has dipped its toe in the U.S. market by buying Centura Banks in North Carolina. TD Bank bought online broker Ameritrade, Banknorth in New England and Commerce Bank in New Jersey.

Instead of expanding globally, these Canadian banks have been consolidating domestically and wanted to shrink further until their government stepped in to prevent it. Without the ability to merge and shed overlapping costs in their domestic market, all these banks should be looking to grow elsewhere, and there appears to be no better place than to their south.

Following the U.S. government stress test results last week, all U.S. banks (large and regional) are raising capital in secondary offerings to beef up their capital reserves. There is a feeling that all these banks have a new lease on life. This is a perfect time to be a buyer of these assets at these levels -- it's not necessarily the best time to be a seller if you think things are finally starting to brighten up after the last two years of thunderstorms.

The Canadian banks should be going after the best of the large U.S. regional banks. Royal Bank of Canada is large enough to make a run at PNC Financial(PNC Quote). Any of the Canadian banks could look to digest smaller players like People's United (PBCT Quote), Fifth Third(FITB Quote), Marshall & Isley(MI Quote), Huntington Bancshares(HBAN Quote) and First Niagara (FNFG Quote).

Banks in the Southeast, such as BB&T(BBT Quote), Suntrust(STI Quote) and Regions Financial(RF Quote), might be more open to a buyout deal but could bring more risk with their current loan portfolios. However, with the large number of Canadian snowbirds who vacation or live in Florida, there could be an advantage to having a large footprint in that state.

Last summer, Scotiabank was one of the suitors sniffing around the assets of National City before PNC took it over. There is a big difference between some of the healthier regional banks today and Nat City then.

There are still risks facing the Canadian banks. The Canadian economy generally lags the U.S. and unemployment is likely to get worse over the coming months (although Canada actually added jobs in April). As unemployment rises, so too will the banks' losses from credit cards, mortgages and auto loans.

Yet with a newly strengthened Canadian dollar and the banks' relative strength, this could be a golden opportunity for the Canadian banks. They should not squander this chance at making serious inroads into the U.S. market.

At the time of publication, Jackson was long Fifth Third.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

This article was originally published in TheStreet.com

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Canadian Banks: Risk-Averse, Not Immune

From TheStreet.com

By Eric Jackson

03/09/09 - 08:19 PM EDT

The Canadian banks have been getting a lot of attention lately. Last October, the World Economic Forum rated them the best in the world, ahead of Sweden, Luxembourg and Australia.

Compared with their basket-case brethren in the U.S., they look positively healthy. They never took on excessive mortgage risk, as Canada was never awash with subprime mortgages or securitization of the loans after the fact. Things like "no documentation of income" never flew in Canada, where bankers have always tended to be pretty bankerish, generally demanding 20% down.

The Canadian economy hasn't been prone to economic booms and busts like the U.S.' Equities never went up as much in the dot-com heyday, and home prices increased over the last few years, but not like the overheated U.S. markets. Also, Canadians never had the same wealth created (or credit available to them) over the past few years to allow a large number of families to buy second, third and fourth investment properties to the extent that happened in the U.S..

So as the banks around the world have imploded, the six largest Canadian banks: Royal Bank of Canada(RY Quote - Cramer on RY - Stock Picks), Bank of Nova Scotia(BNS Quote - Cramer on BNS - Stock Picks), Toronto Dominion Bank(TD Quote - Cramer on TD - Stock Picks), Bank of Montreal(BMO Quote - Cramer on BMO - Stock Picks), Canadian Imperial Bank of Commerce(CM Quote - Cramer on CM - Stock Picks), and National Bank of Canada (TSE) -- have looked like stalwarts.

Most are still reporting earnings, have relatively low exposure to U.S. loans, and are in strong capital positions to expand their market positions globally as others wilt.

So, the question is why haven't these banks' stocks done even better over the last few months. The five U.S.-traded Canadian banks have all lost over half their value in the last year. They've certainly done better than Citigroup(C Quote - Cramer on C - Stock Picks) and Bank of America (BAC Quote - Cramer on BAC - Stock Picks), but that stock performance is only roughly in line or worse than JPMorgan Chase(JPM Quote - Cramer on JPM - Stock Picks). Shouldn't these stocks be doing appreciably better, if the banks are that much stronger?

I think the management teams and boards of the Canadian banks should be congratulated for managing their businesses so well, especially when compared to the greed and recklessness that their global competitors were operating under. I believe the market's discounting of the Canadian banks stock prices in the past year is not a reflection of what they've done, but concern over what's ahead.

The biggest concern facing Canadian banks is the future health of the Canadian economy. Although Canada rode the oil and resource boom through last June to low unemployment and a booming dollar (which at its peak was worth C$1.10 for every US $1), and many in Canada assumed that the country was "decoupled" from the problems afflicting the U.S. even as late as last September, we now know that the northern economy is tightly connected to the U.S. and world economies.

In the '80s and '90s, Canada consistently and stubbornly hung on to a higher unemployment rate than the U.S. Canadian workers have been less mobile than their American counterparts, and retraining certain swaths of society has been difficult. In the last major downturn or the early '90s, the spread between Canada and U.S. unemployment grew to over 4%.

What's more, this gap remained at these levels until 1998, when the gap started to close to only about 2% by 2002 and recently closed entirely as the U.S. rate started to tick up before Canada's did.

Quite simply, Canada lags the U.S. when it goes into an economic slowdown and takes longer to come out of it. Despite the resource boom, a large part of Canada's economy remains tied to manufacturing and shipping those goods to the U.S. A weaker Canadian dollar for much of the last decade gave these Canadian manufacturers a big advantage sending goods to the U.S. As the Canadian dollar rose to parity with the U.S. dollar in the last 18 months, that cost advantage went away, but oil, resources and the Canadian economy remained healthy.

Now, six months after Lehman collapsed and the world economy has gone into free fall, the Canadian economy is hurting. In January, the Canadian economy lost 129,000 jobs and saw its unemployment rise 0.6% to 7.2%. That same month, the U.S. economy lost more than 500,000 jobs and saw its unemployment rate climb 0.4% to 7.6%.

The rate of job loss is rising faster in Canada, and remember that Canada is 10% the size of the U.S. Imagine if the U.S. Department of Labor had announced the American economy had dropped 1.3 million jobs in the month of January, and you understand what is going on north of the border.

We know the U.S. unemployment rate is now up to 8.1% through February, but the Canadian government has yet to provide comparative data. You can expect the job losses to continue to pile up over the coming months. If the U.S. finally tops out at 10%-11% unemployment next year, as many economists call for, it is not unreasonable to expect Canada to go back to its 4% spread of 14%-15% unemployment. It is this scenario that worries Canadian bank investors and the banks' potential future losses on credit cards, auto loans and mortgages (both consumer and commercial).

There are silver linings for the Canadian economy and its banks. The Canadian dollar has already dropped to being worth US 80 cents and it could go lower, which helps Canadian manufacturers compete against U.S. companies for jobs. Canadian consumer indebtedness is healthier than in the U.S., which hopefully contributes to continued spending in the domestic economy. The Canadian government has also done little to stimulate the economy and is in a strong fiscal position to do so, if needed.

The Canadian banks are in a strong capital position to weather the coming storm and will certainly use that strength to expand into the U.S. opportunistically at some point in the next three years. But investors might choose to wait on buying these "soundest banks in the world" until they better understand how long and how deep the recession will last in Canada.

At the time of publication, Jackson had no positions in stocks mentioned.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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