REFILE-Investors prefer Canadian banks put record excess capital into M&A over share buybacks

(Refiles to remove extraneous word in headline, fix spelling error in 12th paragraph.)

By Nichola Saminather

TORONTO, Dec 23 (Reuters) - Investors are urging Canadian banks to deploy their record levels of excess cash on acquisitions that will aid long-term growth before buying back shares.

Questions about how lenders will spend the C$70 billion ($54.52 billion) they are holding above the current regulatory minimum is drawing increased focus after regulators in the United States, Europe and Australia began lifting prohibitions on returning some capital to shareholders in the last week.

Analysts and investors expect Canada's Office of the Superintendent of Financial Institutions (OSFI) to lift its March moratorium on share buybacks and dividend increases in mid- to late-2021.

The global moves are "telling me they think the worst is behind them," said Allan Small, senior investment adviser at Allan Small Financial Group with HollisWealth, urging Canada to lift the freeze "sooner rather than later."

But investors are not enthused about the EPS growth expected to result from a resumption of buybacks, which some investors see as artificial because it results from a smaller share base, not organic growth.

Rather, they want banks to use the money to strengthen their financial technology and pursue acquisitions, particularly in the United States, in wealth management and other recurring fee-generating businesses and those that will bolster organic growth.

"Acquisitions allow the banks to continue to grow at a time when many people feel that growth in Canada is grinding to a halt," Small said.

Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada had C$262 billion of Common Equity Tier 1 (CET1) capital, a measure of core capital, in the October quarter.

That is the highest since the tougher capital requirements of Basel III took effect in 2013, despite OSFI's reduction of the minimum requirement to 9% of risk-weighted assets in March.

Even under a minimum 11% CET1 ratio, expected when the coronavirus crisis abates, banks have nearly C$30 billion of excess capital, and this amount is expected to grow next year.

Returning this to shareholders would lift 2021 earnings per share by between 3.1% and 8.4%, with National Bank at the bottom and TD at the top, Barclays analysts wrote in a Dec. 10 note.

"From an optics perspective, share buybacks do help," said Manulife Investment Management Senior Portfolio Manager Steve Bélisle. "But we don't think this is good quality growth."

Canadian banks' valuations, near historically high levels, also make buybacks less attractive, said Baskin Wealth Management Chief Investment Officer Barry Schwartz.

The banks index is only 2% below its year-ago level, having recovered 53% from its March low.

Meanwhile, Canadian lenders are trading near a 40% premium to U.S. regional banks' book values, making acquisitions attractive, National Bank Financial Analyst Gabriel Dechaine wrote last week.

"Although we are often skeptical of the value creation promise of acquisitions, timing can be a major difference-maker," he said. "In that sense, we believe the current environment is likely as good as any to do a deal." ($1 = 1.2839 Canadian dollars) (Reporting By Nichola Saminather; Editing by Cynthia Osterman)