The big news on the Canadian financial stock front is that TD Bank (TD: TSX) has agreed to buy Commerce Bancorp, a regional US bank. As the Financial Post article indicates, TD is taking advantage of our historically high dollar to leverage their buying power in the US. Our banks have become relative minnows as financial institutions around the world have consolidated since the early 1990s. The big 5 in Canada have not participated in this wave due to federal regulations restricting mergers within our domestic banks as well as regulations limiting the amount of foreign ownership in Schedule 1 banks.

While Canadian banks have not kept up with global competitors in terms of size, they have exceeded the typical global financial conglomerate in terms of profitability and shareholder return. Since our banks face little competition on the retail banking side, they have been able to milk consumers for high profit margins. Meanwhile, global banks have faced stiff competition around the world as they begin to tread on each other’s turf. As a result, large firms such as Citigroup and Royal Bank of Scotland have underperformed our little banks to a large extent. Overall, our financial sector has outperformed similar US firms over the medium term.

While having Canadian banks eat up smaller US and other global firms may give shareholders and management a good ego boost, I wonder about the long term affect on the bottom line. Most Canadian banks have mixed records of integrating foreign assets into their operations, and rarely have any such assets ever met the same rates of return on capital that domestic operations have. Such acquisitions invariably reduce short term earnings, which may never become accretive. That said, I understand the trepidation that such banks face, seeing how small they have become.

Nonetheless, I am more interested in firms who are looking for higher growth areas than the US. For instance, Scotiabank (BNS: TSX) has a much more emerging market-oriented strategy, which I believe can produce similar rates of return (or at the very least similar absolute earnings growth) to domestic operations.

Make sure you evalute your Canadian financial holdings when they make foreign acquisitions. Depending on the size and scope of the deal, it may materially affect their performance for years to come.