UPDATE 3-Royal Bank of Canada to buy Ally auto finance unit

* Deal positions RBC as a leading auto lender in Canada

* Ally to receive proceeds of about $4.1 bln

* RBC shares fall 1.7 pct in early trading

TORONTO, Oct 23 (Reuters) - Royal Bank of Canada has agreed to buy the Canadian auto finance and deposit arm of Ally Financial Inc in a $4.1 billion deal to expand its vehicle-lending business at a time when loan growth overall is slowing in the country.

Canada's largest bank said on Tuesday the deal would give a big boost to its existing domestic consumer and commercial auto financing business, and position it as a leader in the segment.

Ally, majority-owned by the U.S. Treasury, outlined plans in May to sell its international operations, aiming to speed up repayment of government bailouts during the financial crisis.

The company is the former auto lending arm of General Motors Co. Last week it agreed to sell its Mexican insurance business to ACE Ltd for $865 million.

Ally expects to receive total proceeds of about $4.1 billion from the sale of its Canadian business. RBC said its cash outlay on the deal would be between $3.1 billion and $3.8 billion, as it is contingent on the size of the dividend that Ally intends to extract from its Canadian business before closing.

While Canadian banks still churn out steady profits, they have been struggling lately to spur growth in the face of slowing loan growth and narrow interest margins.

Given this backdrop, analysts said the deal may be good for RBC, noting that auto lending - at least on the personal side - is one of the areas that has continued to experience relatively strong growth.

``We view the transaction positively as it increases scale and builds out Royal's very profitable domestic franchise,'' said Barclays analyst John Aiken in a note to clients.

The deal, which requires regulatory approval, is expected to close in the first quarter of 2013. RBC competed with another Canadian bank, Toronto-Dominion Bank, in an auction for the assets, a source told Reuters on Monday.

The Canadian banking industry is dominated by six domestic banks, and the federal government discourages mergers among them, making growth opportunities hard to come by. Given this scenario, any assets that come up for grabs in Canada typically attract a flurry of interest.

``We believe this deal will deliver long-term strategic value and provide significant opportunities given the strength of the combined business and the attractive dynamics of the industry,'' RBC Chief Executive Gord Nixon said in a conference call.

``In summary, of all the deals we looked at in Canada, this was the one we really wanted,'' he said.

In August, Canada's No. 3 lender, Bank of Nova Scotia , trumped RBC and others in a bidding war for ING Groep's Canadian online bank. Amsterdam-based ING put the unit up for sale earlier this year, as part of a series of planned asset divestments to raise funds to repay a Dutch government bailout from the 2008 financial crisis.

RBC announced its transaction with Ally on Tuesday at the same time as TD Bank struck a deal to buy U.S. retailer Target Corp's credit card portfolio.


``This deal is consistent with our goal of being a financial leader in financial services in all areas of our domestic market, and the acquisition positions RBC as a leader in the auto finance business in Canada,'' Nixon said.

Even so, shares of RBC along with other Canadian banks pulled back on Tuesday, after the Bank of Canada held its key rate at 1.0 percent and softened its bias on an interest rate increase somewhat by making the timetable for such a move less definite.

Shares of RBC were down 1.7 percent at C$57 at 10:45 a.m. (1445 GMT) on the Toronto Stock Exchange.


Ally's Canadian arm offers commercial loans to more than 580 auto dealerships across the country, while its consumer business offers retail financing to Canadian consumers through about 1,600 dealerships.

RBC expects the Ally Canada business to generate about $120 million in net income on a standalone basis within the first 12 months after closing. The deal is expected to modestly boost RBC's earnings per share in the first year after closing.

Ally Chief Executive Michael Carpenter said in a statement the lender would evaluate options for its remaining operations in Europe and Latin America, and expects to identify its plans in November.

Ally's international operations in Europe, Canada, Latin America and Mexico have drawn interest from more than 30 bidders, including banks and GM, a source familiar with the situation told Reuters on Monday.

The lender's Canadian operations, based in Toronto, are its largest outside the United States, with $13.6 billion in assets at the end of the third quarter. Ally's international business assets totaled $31 billion, according to data in a recent company presentation.

Ally is aiming to turn around its operations by focusing on U.S. auto lending and banking.

Its Residential Capital mortgage unit filed for bankruptcy in May in a bid to protect the parent company from lingering liabilities tied to home loans it sold to investors during the housing boom.

An auction for ResCap's mortgage servicing and lending operations begins on Tuesday in New York. A consortium of Ocwen Financial Corp and Walter Investment Management Corp is vying with Nationstar Mortgage Holdings Inc to buy the business, sources told Reuters last week.