Canadian Banks' Southern Exposure

Its big outfits have been hurt by their U.S. expansion

In the late 1990s, Canada's four biggest banks all concluded they had outgrown their vast but underpopulated country. Cash-rich and eager to become global players, Royal Bank of Canada, Bank of Montreal, Toronto-Dominion Bank, and the Canadian Imperial Bank of Commerce (CIBC) made heavy investments south of the border. All bought financial-services outlets in the U.S., while Toronto-Dominion snapped up Waterhouse Investor Services Inc. and CIBC followed up by buying securities and mutual-funds giant Oppenheimer & Co. At the same time, the banks jumped headlong into the tech and telecom boom, making heavy loans to companies like Nortel Networks in Canada and Global Crossing Ltd. in the U.S., in part to attract investment banking.

The ventures were mostly disasters. Toronto-Dominion recently wrote off $820 million of the $3.9 billion it loaned to telecom companies and announced a loss of $269 million for the third quarter, its first in 15 years. CIBC estimates it will lose $945 million on its loan portfolio this year, Bank of Montreal $520 million, and Royal Bank of Canada $523 million.

But the Canadians are determined to try, try again. Far from backing out of the volatile U.S. market, they are increasing their bets. "Shareholders want Canadian banks to make their mark on the global stage," because that's where the growth is, says David K. Picton, portfolio manager at Toronto-based Synergy Asset Management Inc., a big shareholder in several banks. Royal Bank of Canada alone has spent some $3.8 billion on acquisitions in the past two years, buying two small banks and an insurance company in the U.S. Southeast, plus local brokerage firms in Minneapolis and Boston.

In February, Bank of Montreal bought online broker CSFBdirect and in May added an online unit of Morgan Stanley. Bank of Montreal is gearing up to expand Harris Bank, Chicago's third-largest financial institution, which it has owned since 1984. CIBC has been offering retail banking services to Safeway and Winn-Dixie Stores supermarket customers since 2000, while TD last year struck a deal to do the same for Wal-Mart Stores.

Are the Canadians gluttons for punishment? No, say the Bay Street elite, they just can't afford to ignore their big southern neighbor. "Just greater Chicago's economy represents approximately 40% of the Canadian GDP," points out Yvan Bourdeau, chief operating officer of BMO Nesbitt Burns, Bank of Montreal's U.S. investment banking arm.

Unfortunately, the Canadian banks plunged back into the U.S. market too soon. Royal Bank's new southern arm turned a meager profit of $35 million in the third quarter. CIBC has lost $185 million on its supermarket venture and is looking for a way out. And analysts are skeptical of Bank of Montreal's big plans for Harris Bank, since competitors like Bank One and Bank of America also have expansion plans in the Chicago area.

What can the Canadian banks do to increase their heft? Merge, say some observers. The largest of the group, Royal Bank, boasts just $225 billion in assets, which makes it tiny compared with most U.S. and European behemoths. "A merger would mean better capitalization and would give these institutions higher stature internationally," says Jack Dzierwa, banking analyst at Salomon Smith Barney in Toronto. But a proposal to merge the four banks into two was rejected as anticompetitive by the Ottawa government in 1998. Given their recent troubles, the banks are trying to persuade regulators to reconsider.

In the meantime, Canada's banks aren't likely to pose much of a threat to their U.S. brethren. And their vision of making a big footprint on the world is a dream deferred.

By Pallavi Gogoi in Toronto

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