Canadian banks on acquisition spree

This article originally appeared on canadianbusiness.com.

Canadian banks are on an acquisition spree, having completed 118 purchases since 2008.

In October, RBC scooped up the Canadian auto-lending and deposit business of Ally Financial—in a deal valued at US$4.1 billion—and TD Bank plunked down $6 billion for the credit-card portfolio of Target.

And in August, Scotiabank made headlines internationally by securing ING Bank of Canada for $3.1 billion.

Read: Pros and cons of Scotia’s ING purchase

In fact, the Big Six banks have completed approximately 50 acquisitions in the past two years, says Dealogic. And one common theme underpins a lot of these moves: consumer lending.

It’s the bread-and-butter of Canadian banks, and isn’t as profitable as it once was. “That basically forces the banks to seek new opportunities,” says Brad Smith, an analyst with Stonecap Securities.

Traditionally, the banks have made money by borrowing funds at short-term interest rates, lending out to consumers at higher long-term rates, and then profiting from the difference.

But the gap between short- and long-term rates has narrowed since the financial crisis, squeezing profit margins.

Read: Were Canada’s banks bailed out?

Moves like Scotiabank’s purchase of ING offer banks greater access to deposits, a cheap source of funding that can help it maximize profits on the interest rate spread.

Likewise, part of the appeal of Ally for RBC is auto loans come with relatively high interest rates. The financing arms of auto manufacturers have also dominated the sector for the past decade or so, while banks have played a limited role. Now, they’re stepping in after the recession hammered auto companies.

Read: RBC scoops up Ally Financial for $1.4 billion

While auto finance represents somewhat fertile ground for the banks, RBC’s Ally purchase doesn’t address the biggest problem facing the sector: Canadians can’t keep borrowing as they have.

The average household debt stands at a record high of 163.4% of disposable income; Moody’s Investor Service recently put five of the six major banks on downgrade watch, in part due to concern about consumer debt.

Read: Moody’s downgrade threat unwarranted: RBC

When people finally curb their appetite for borrowing, the mortgage, credit card and auto-lending arms of the banks will all slow down, says Peter Routledge, a financial services analyst at National Bank Financial.

He adds, “The deal RBC made gives them a bit more earnings, but I don’t think it changes the equation at all.”

He says banks can respond to dimmer prospects domestically in two ways: cut costs or expand abroad.

Read: Canadian banks too inefficient to compete: S&P

This explains why TD is making a huge push into the U.S., where it now has more branches than in Canada. TD has accumulated a lot of deposits through those branches, and is working on growing its loan portfolio to maximize returns.

This is also why it purchased Target’s credit card portfolio and U.S. auto lender Chrysler Financial in 2010. Similarly, BMO is expanding stateside.

Many analysts argue Scotiabank, the most international of the Big Six, is the best positioned for the years to come. RBC, meanwhile, is more vulnerable to the coming lending slowdown at home, and it’s unlikely that auto finance on its own will be the solution.

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