What Are Canadian Banks Waiting for?

I couldn’t believe it has been 10 years ago to the day since the surprise announcement of a merger between Royal Bank of Canada and Bank of Montreal. I remember the excitement in the office and on the Street, and everyone’s rush to buy bank stocks. Any bank stock!

At the time, Royal Bank’s John Cleghorn uttered the now almost famous words, “No more dicking around on the beach.” The statement was supposed to be a ringing endorsement of Canada’s banks finally maturing to size (literally) and entering the Big League (metaphorically).

Of course, leave it to Ottawa to be the party pooper. The feds said “no” to the merger, putting their foot down firmly so that no one else could get a similar idea. Since then, Canadian banks have lost their sizzle, if they had any to begin with.

I remember Ottawa brooding something about consumer protection, the creation of banking monopolies, bank fee threats, etc., which, I’m sure made sense on some level and to some people. On the other hand, there was always a price to be paid for inertia.

There is no pretty way of saying this, but as far as global rankings go, Canada’s banks are down there with the bottom feeders. When it comes to size, it does matter, regardless who says otherwise. To illustrate, during the 1990s, Canada’s five largest banks were cumulatively the size of one of New York’s Chase Manhattan. And our (largest) pride and joy, Royal Bank, has a market capitalization of less than half the size of Citigroup, even after the latter has been decimated by the subprime mortgage crisis.

The answer always was and still is — mergers! Since domestic mergers don’t really offer much in terms of competitive size, the obvious solution is branching out. Better yet, because of the credit crisis in the U.S., this solution has been delivered to Canadians on a silver platter. If banks wanted to expand, and had the gumption to do it, now would be the time!

Why? A simple comparison between Canadian and American banking systems should suffice. Just for the five-year period between 2001 and 2006 — so before all the subprime smelly stuff hit the fan — Royal Bank, for example, never had a year during which more than 0.7% of its loans had to be written off. In contrast, Citigroup never succeeded to write off less than one percent in bad loans. There were even a couple of years when write-offs were higher than two percent.

Furthermore, it was in the late 1990s when Citigroup last posted a return on equity of 20%, while the fastest-growing-through- acquisitions Wachovia has barely averaged a return on equity of 12.7% for the past five years. In contrast, Royal Bank hit that sweet spot of the 20% return on equity both in 2006 and in 2007.

Not surprisingly, U.S. banks are now on the chopping block at bargain prices. The only issue is whether Canadian banks want to take on all the baggage of the U.S. subprime mess, too. I’m sure many are burning the midnight oil at Royal Bank or at Bank of Montreal, trying to figure out margins of error in their merger evaluations. These could make or break the deal. But the fact remains that if Canadian banks wanted to grow through acquisitions, there is no better time than now!