Last week, in our insight “U.S. Bank M&A: Implications of the Largest Deal in a Decade”, we explained why we expect U.S. bank consolidation will accelerate following the BB&T/SunTrust merger, and reasons why such activity will predominately be within the small and mid-cap banks. In this insight, we offer five takeaways for the Canadian banks – BMO, CM, RY, and TD – and their U.S. expansion plans.
These four Canadian banks have sizable U.S. commercial banking platforms (combined commercial bank assets of ~$US500 bln) operating in some of the largest and most competitive metropolitan statistical areas (“MSAs”) in the country, including Chicago, New York, Los Angeles, Boston and Philadelphia. As a result, U.S. banking trends, including M&A, are important to the Canadian banking sector.
Of note, the Hamilton Capital ETFs have meaningful exposure to U.S. banks, with:
- 70% of Hamilton Capital U.S. Mid-Cap Financials ETF (USD) (ticker: HFMU.U) invested in 40 mid-cap banks;
- 45% (~20 mid-cap banks) of Hamilton Capital Global Bank ETF (ticker: HBG); and
- ~15% (8 banks) of Hamilton Capital Global Financials Yield ETF (ticker: HFY)
Our Hamilton Capital Canadian Bank Variable-Weight ETF (ticker: HCB), which employs a rules-based mean reversion strategy, owns all of the Big-6 Canadian banks. An increase in U.S. bank acquisitions of the Canadian banks could result in increased volatility. This could be a positive for HCB – relative to the index or an equal-weighted portfolio – should the sector’s long-term historical mean reversion tendencies persist.
Five Takeaways to the Canadian Banks from Accelerating U.S. Bank M&A
We believe the four Canadian banks with U.S. commercial banking platforms – BMO, CM, RY and TD – will seek to support the growth of these platforms with further acquisitions. If we are correct, such activity will impact share performance making their decisions on how fast and how much to grow through M&A significant to investors. If the BBT/STI merger-of-equals (“MOE”) – the largest U.S. bank deal in a decade – indicates an acceleration of U.S. bank consolidation, we believe the following to be key implications for the Canadian banks:
- A BBT/STI-like MOE not an option; Canadian banks will pay premiums: The positive market reaction to STI/BBT merger cannot be assumed for the Canadian banks since it was a merger-of-equals. U.S. investors favour this deal structure since: (a) it allows for more balanced sharing of the economic benefits/synergies, and (b) lower premiums reduce deal risk. For obvious reasons, Canadian banks cannot participate in MOE transactions, meaning any acquisitions they make will necessarily involve paying the target shareholders takeover premiums.
- Moving acquisition plans forward = higher acquisition risk: The management teams of the Canadian banks are no doubt aware that after a very long period of limited deal activity, the sheer size/significance of the BBT/STI merger could catalyze an acceleration in M&A activity. This may in turn cause them to pull forward any expansion plans. Because Canadian banks have routinely experienced multiple compression/underperformance relative to their peers after making acquisitions, we believe acquisition risk has risen.
- TD most likely to make large U.S. deal in 2019 (how big will it go?): Even before the BBT/STI announcement, there were signs that TD was the most likely Canadian bank to make a (possibly) large acquisition in 2019. Given TD’s focus on the Southeast and the fact that the BBT/STI deal could precipitate further regional consolidation, TD could be prompted to become more aggressive in either the timing or size of its next deal. Given that TD’s Southeast platform was established through the acquisition of failed/failing banks during the financial crisis, upgrading this platform is almost certainly an important strategic priority.
- BMO, CM have (a bit) more flexibility: While we anticipate BMO and CM will make further acquisitions in the near to medium-term, in our view, they have more flexibility on timing given that the Midwest MSAs in which they compete are more fragmented. That said, we believe growth through acquisitions will remain a strategic priority for both banks.
- RY has lowest U.S. bank acquisition risk: The idiosyncratic nature of City National (ultra-wealthy clientele, targeted customer base) makes it less vulnerable to further market concentration. As a result, we believe that of all of the Canadian banks, RY has the lowest U.S. bank acquisition risk.
If U.S. bank consolidation accelerates, we believe the four Canadian banks with U.S. platforms will participate as the strategic implications of standing by and watching the market consolidate are too significant. As a result, in the coming years, the Canadian banks have some very important decisions to make, with meaningful implications for investors.
Other Hamilton Capital Insights on U.S Bank Consolidation:
100 Bank Mergers (Three Years Later); November 25, 2015
100 Bank Mergers; December 13, 2012
 For more details, please see our discussion of volatility in our September 27, 2018 insight, “Canadian Banks: Mean-Reversion Strategy for Higher Returns/Lower Risk”.
 Specifically, three small failed Florida banks (US$3.8 bln in assets) and the much larger The South Financial Group, which was headquartered in South Carolina (US$12.4 bln in assets), which would have likely failed had TD not acquired it in a take-under.