Toronto-Dominion Bank is in talks to buy lender Chrysler Financial from private equity firm Cerberus Capital Management , a source said on Tuesday.

The deal, pegged by a Bloomberg report to be worth as much as $6 billion to $7 billion, would continue TD's torrid pace of U.S. acquisitions and could give the bank a first-mover advantage if Canada's government amends laws that currently prevent banks from offering auto leasing, said one observer.

TD Chief Financial Officer Colleen Johnston, speaking at an investor conference in New York, declined to comment directly on Chrysler Financial, but she appeared to pour cold water on the idea of a big acquisition.

Our current interest is in more modest-sized deals that will perhaps give us some distribution or asset-generation capabilities, she said. We are not looking at anything on a significant scale at the moment.

Separately, The Wall Street Journal reported that Cerberus could retain some assets, which would cut the size of a deal.

It said several parties, including TD and ING , were in talks with Cerberus for a deal for Chrysler Financial.

TD's shares, which were flat for much of the session, rallied late to close up 1.9 percent at C$72.17, rebounding from a three week low on Tuesday

Cerberus declined to comment, while Chrysler Financial was not immediately available for comment. The source asked for anonymity because the TD-Cerberus talks are not public.

Chrysler Financial, the former lending arm of the automaker, saw its scope of operations reduced as part of a U.S. government-sponsored restructuring of Chrysler and General Motors last year. Ally Financial Inc, the auto and mortgage lender formerly known as GMAC, took over some of the unit's operations in connection with the restructuring.

Cerberus, co-founded by Stephen Feinberg and named after the mythological multiheaded dog that guards the gates of the underworld, agreed to buy Chrysler in May 2007.

Chrysler was put through bankruptcy with financing from the U.S., Canadian and Ontario governments and is now majority-owned by a trust fund aligned with the United Auto Workers union, and operates in a partnership with Fiat SpA. Cerberus retained ownership of Chrysler Financial.

In September, another source told Reuters that Chrysler Financial was planning to boost its business through lending to mid-market companies and near-prime customers.

TD EXPANSION

TD, which is Canada's second-biggest bank, has been pushing aggressively into the United States over the past five years.

Its U.S. East Coast retail bank network now boasts about 1,300 branches -- more than Toronto-Dominion operates in Canada. It also owns just under half of U.S. online broker TD Ameritrade .

One analyst, who is not authorized to speak on the matter, said the deal was a surprise as it would diverge from TD's recent approach of building its branch network gradually through mostly small acquisitions.

However, he noted TD could leverage its already strong customer base through its retail bank.

As well, he said TD is not wholly unfamiliar with the auto lending business, having bought Canadian high-risk auto financing company VFC Inc in 2006.

TD Chief Executive Clark has been the most vocal of Canadian bank CEOs on the matter of allowing auto leasing through banks, which has emerged as a hot-button issue in advance of a five-year review of Canadian banking law.

Currently, the banks are not allowed to offer auto leasing, but they have been pushing for that to change, citing the financial crisis, which had a devastating effect on auto leasing companies.

Ian Lee, a professor at Ottawa's Carleton University and a former banker, said buying Chrysler Financial would suggest TD believes the government will approve a shift into leasing.

Buying this company that's been in this business for years and years is astute on TD's part, it will give them a first-mover advantage into leasing, he said.

Lee was not sure whether TD would be able to offer leasing through its U.S. branches if Canadian banking laws are not amended.

TD is generally seen as having the strongest government connections of any of the country's banks, as TD Deputy Chairman Frank McKenna is a former provincial premier and ambassador to the United States, while Clark himself is a former bureaucrat.

($1 = $1.01 Canadian)

(Reporting by Cameron French in Toronto and Paritosh Bansal in New York; editing by Peter Galloway, Rob Wilson and Matthew Lewis)