The Globe & Mail has a storyline out today that caught my eye. It suggests that Royal Bank of Canada (RBC) would find some god takeover opportunities in the US. While I dismissed a similar storyline regarding UBS in Europe from the Financial Times, the Globe & Mail story does make sense.
This past week, the FT suggested that UBS look to go shopping for other European banks.
The European banking sector has not been this cheap – now trading on a single digit prospective price/ earnings ratio – for 16 years. There are high-quality Spanish names on seven times earnings and more wobbly, but ultimately fine, UK banks below five times. Price-to-book ratios are at decade lows.
Yet in spite of the bargains most banks say they have little interest in large acquisitions, claiming to be happy with their existing business models and strategies. That is delusional for quite a number of banks and just lazy thinking for others. For well-capitalised banks such as UBS, now is a perfect time to consider acquisitions as part of a more general restructuring.
Nor should highly valued banks such as Credit Suisse sit back and think that their premium ratings vindicate their strategy. Many were either lucky to avoid or late to get into the products that have damaged their rivals – such banks would be wise to use their equity currency before valuation gaps close.
This idea is good outside the box thinking, So, I hate to rubbish the idea, but UBS is not over the hurdle yet. UBS is a bank that has written down nearly $40 billion in equity due to investment missteps before the global financial crisis. Moreover, events in the UK, Ireland and Spain have yet to play out in full. I know that UBS has exposure to the UK and I suspect more writedowns are to come. Therefore, they company is ill-placed to consider a takeover at this point in time. Credit Suisse might give it a go despite the obvious risks.
Now, RBC is a different story altogether. They have had few writedowns from U.S. exposure, they have a limited U.S. presence and Canada does look less fragile than the U.S. in terms of housing and the economy. This is an intriguing idea.
In a note to clients yesterday titled Fish or Cut Bait, Time to Start the U.S. Acquisition Machines, CIBC World Markets analyst Darko Mihelic argued that RBC, followed by Bank of Montreal, is best positioned to take advantage of opportunities cropping up in the U.S. and “perhaps now is the time to think big.”
RBC has spent nearly $5-billion (U.S.) since 2001 to build up a presence of about 450 branches in six U.S. states, but its U.S. and international segment accounted for little more than 3 per cent of profits in the past year, Mr. Mihelic noted.
The bank signalled in April that it was increasingly looking for growth outside of Canada when it promoted Jim Westlake to run its international banking and insurance operations.
The bank wants half of its revenue to come from non-Canadian sources in the next five to 10 years, Mr. Westlake said in an interview at the time.
“Canada’s a relatively small country in the global marketplace and we want to look at all opportunities.” Currently, almost one third of the bank’s revenue comes from non-domestic sources.
Mr. Mihelic cited Alabama-based Regions Financial Corp. and North Carolina-based BB&T Corp. among the banks that RBC could profitably swallow.
The U.S. regionals are in dire straits at present. They might welcome a foreign suitor with a strong balance sheet. Moreover, cultural differences between the U.S. and Canada are limited, making integration potentially much easier. The idea had been floated that RBC would make a go at Lehman Brothers (or Bear Stearns back before JP Morgan stepped in). However, culturally, that would be a bad fit and a disaster. Lehman’s freewheeling Investment Bank culture would not sit well under the auspices of a foreign commercial bank.
The risks are high because we are not even close to fully through this crisis, but valuations for regionals are low. Now might be the time to get in there and give it a go.