BUSINESS

Survival of the biggest

Canadian financial services companies combine to compete

July 26 1993
BUSINESS

Survival of the biggest

Canadian financial services companies combine to compete

July 26 1993

Survival of the biggest

BUSINESS

Canadian financial services companies combine to compete

Alphonse Desjardins might have mixed feelings about the latest development at the family of credit unions he established almost a century ago. Desjardins was a journalist who founded the first “caisse populaire” in Lévi, Que., in 1900.

He intended the customerowned credit unions to provide competition for the chartered banks, which, he felt, were charging excessive interest rates, if they would lend money at all, to the FrenchCanadian working class. Over the next 16 years, he helped to establish another 205 credit unions in the province, building a foundation for the diversified financial group that now bears his name. Earlier this month, the Desjardins Group announced a proposal to take over the Montreal-based Laurentian Group Corp., which controls Laurentian Bank and other interests, bringing together the two largest financial institutions in Quebec with combined assets of $77 billion.

“Alphonse would be very happy,” Desjardins chairman Claude Béland told a news conference in Montreal when the deal was announced on July 7. “I prefer controlling one bank to being eaten by them.”

Still, Alphonse Desjardins probably would have worried about furthering the trend to consolidation in Canada’s financial services industry.

Even before the merger announcement, the $56-billion Desjardins Group was the largest financial institution in Quebec. But with the addition of Laurentian’s $21 billion in assets, Desjardins will control even more of the market—a situation that has prompted the Federal Bureau of Competition Policy to launch a review of the proposed deal. In fact, the combination of Desjardins and Laurentian is just the latest in a major round of banking mergers and acquisitions. And a recent Conference Board of Canada survey of chief executives of Canada’s leading 35 financial institutions found that they expect even more rationalization ahead—and that they believe that size is critical for success in deregulated fi-

nancial markets. Says Conservative MP Donald Blenkarn, a former Commons finance committee chairman and sometimes an outspoken critic of the banking industry:

“In the future, we may see no more than 15 major financial service companies in Canada. That will mean a lot more consolidation in the life insurance industry and the trust industry.”

For their part, consumer groups and small and medium-sized businesses are wary about more concentration in an industry that they claim is already too close-knit. Robert Kerton, a consumer economist with Ontario’s University of Waterloo, dismissed the board’s survey of executives. “That’s like sur-

veying foxes about the care of chickens,” says Kerton. And Catherine Swift, senior vice-president of the Canadian Federation of Independent Business, adds that her 85,000 members are already convinced that they are poorly served by the major banks—and that any new mergers will only reinforce that conviction. “We don’t think that bigger is going to be better for us,” says Swift. ‘We prefer more players and more competition.” In the proposed Desjardins-Laurentian takeover, Laurentian shareholders will be given a still-to-be determined amount of cash plus shares in the new company in return for their Laurentian shares. The share value will be based on the company’s book value adjusted to reflect any problems that may surface after Desjardins reviews Laurentian’s business. The transaction will create the sixth largest financial services giant in Canada. Even more significantly, Desjardins will increase its dominance of Quebec’s banking and life insurance markets. Desjardins already controls a significant share of the market for many of Quebec’s main financial services. After the takeover, its share of the residential mortgage market will increase to 46 per cent from 41 per cent now, and its share of the personal savings deposit market will increase to 43 per cent, from 37 per cent. The deal would also provide Desjardins with Laurentian’s 183 bank branches in Quebec, plus 57 outside the province. Desjardins already has 1,661 credit union outlets in Quebec. Unlike other recent mergers in the sector, however, Desjardins executives said that they will not be able to reduce operating costs by rationalizing the two operations. Even though there will be considerable overlap between the two, they cannot be amalgamated because the credit union business is set up and regulated under provincial legislation, while Laurentian’s bank operations

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are under federal government jurisdiction.

Desjardins’s Béland, an ardent Quebec nationalist who has openly supported separatism, says that amalgamating with a bank is the only way the credit union could expand its operations outside of the province. But Jacques Drouin, president of the Laurentian Group, added that the deal will also help the two institutions to hold their own against increasingly large chartered banks that are aggressively competing for business in Canada’s recently deregulated financial markets. “The banks have been swallowing the trust industry, they have been swallowing the securities business. They are going to get into the insurance business,” says Drouin. “Where do you end up if you don’t do anything?”

Indeed, Desjardins’s acquisition of Laurentian is the third major takeover in the industry since last fall. The Toronto-Dominion Bank took over Central Guaranty Trustco in October,

1992, and the Royal Bank of Canada, Canada’s largest bank, is in the process of acquiring Royal Trustco, Canada’s largest trust company. All three acquisitions have occurred because the takeover targets ran into financial problems after the recessionary collapse in commercial real estate markets. But those three are by no means the only institutions with financial problems—a situation that portends even more financial services consolidation ahead. “There are other companies equally as bad as Royal Trust, which could still blow up,” says Blenkarn. “It’s all built on confidence.”

According to some industry observers, anxious government regulators are now approving financial services mergers that, in a stronger economy, might never have been allowed— or foreseen. Says Robin Korthals, president of the Toronto-Dominion Bank: “Five years ago, no one would have imagined that Royal Trust would be absorbed by the Royal Bank.” But Korthals added that he doubts regulators would even now permit a merger between two large, financially sound banking institutions— whatever the operating savings or efficiencies entailed. Korthals says that a merger of two major Canadian banks could cut operating costs by as much as 40 per cent through employee layoffs and the elimination of duplicate services.

That means that in a low-inflation, lowgrowth economic environment the banks

must find new ways to expand that will spread their fixed operating costs, particularly their expensive reliance on computer technology, over a broader customer base. Korthals says that those operating costs are escalating while the financial institutions’

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ability to increase revenues is restrained by sluggish economic activity.

Still, Laurence Pollock, president of Canada’s smallest domestically owned bank, Canadian Western Bank of Edmonton, disputes the premise that size is the key to survival. Pollock noted that Canadian Western, which has assets of just $550 million, makes up for its higher cost of raising capital by having leaner, focused operations. “The trick for a small financial institution is to have a niche and be different,” says Pollock. “We serve Western Canada and small-end commercial companies. And our retail customers tend to be older.” He insists that his bank will emerge unscathed from the consolidation now taking place. “The [big] banks leave us alone—they know that we’re no threat to them,” he says. “There is always going to be business out there for someone like us.”

But at the same time, the major banks are also lobbying for fundamental regulatory

changes that could affect the ability of small institutions, like Canadian Western, to survive. The big banks want to revamp the federal deposit insurance system so that they bear less of the cost of financial failures within the industry. Currently, Canada Deposit Insurance Corp. (CDIC) will reimburse individual depositors for losses of up to $60,000 in the event of the collapse of a member institution. CDIC levies insurance premiums on banks and trust companies according to the size of their assets. As a result of that practice, the major chartered banks, which pay about 70 per cent of the cost of the insurance, claim that they are unfairly required to pay more than their smaller competitors—even though they are less likely to fail and force their depositors to call upon the insurance system.

Deposit insurance, however, is vitally important to ensure the survival of small institutions. Without it, retail depositors would tend to put their money only in the largest institutions to minimize the risk of failure and of potential losses. As a result, many senior bank executives—as well as shareholders and industry analysts—say they would welcome the end of deposit insurance. Declared Roy Palmer, a bank industry analyst with the brokerage firm Bunting Warburg Inc. in Montreal: “[CDIC] was a ridiculous experiment to create more and more banks. It was the last thing Canada needed. Let’s stop creating banks that can’t compete. There should be fewer banks, stronger banks.” Others, however, consider the cost of the deposit insurance system to be comparatively modest, especially when compared with the government’s cost of cleaning up the financial failures in the United States. Waterloo’s Kerton, a member of a government committee reviewing the CDIC, estimates that the current cost of the recent financial failures amounts to about $1.5 billion in Canada, while bailing out the shattered savings and loan business in the United States is going to cost at least an estimated $500 billion. Furthermore, Kerton notes that the Royal Bank alone wrote its profits down by more than $800 million last year because of its losses in commercial lending to clients such as Olympia & York Developments Ltd. Kerton charges that, with or without insurance, the major banks will always attempt to pass the cost of such mistakes along to their retail customers. Vigorous competition is the only counterbalance to that tendency. Indeed, that is exactly what Alphonse Desjardins had in mind.

BRENDA DALGLISH