Wednesday, December 14, 2005

National Bank's Quebec-centricity très Profitable

The Globe and Mail, Konrad Yakabuski, 14 December 2005

Montreal -- His predecessor used to bemoan the "Pepsi factor" -- his words, not ours -- but National Bank of Canada's Quebec-centricity has been très profitable for chief executive officer Réal Raymond.

Canada's sixth-largest bank has finally outgrown the "also-ran" label that used to sum up its status when analysts compared it to the Big Five. In fact, after posting a 20.7-per-cent return last week on common equity and record profit for fiscal 2005, Montreal-based National is getting the last laugh as a few of its Enron-racked rivals at King and Bay wipe the last traces of mud off their faces.

Mr. Raymond is one of the most polite people you will ever meet. He probably considers gloating inelegant. But he's earned the right to rub his critics' faces in National's results. Since taking over as CEO from André Bérard in early 2002, Mr. Raymond has produced 12 consecutive quarters of impressive earnings growth by doing what all the naysayers said he shouldn't: He has reinforced National's dependence on the Quebec market.

Back in 2002, not many were buying Mr. Raymond's sales pitch. Most dismissed his spiel that National could thrive as a "super-regional" bank as an excuse for the fact that it either couldn't find a merger partner in English Canada or that, as the only francophone-led member of the Big Six, it couldn't find one acceptable to the Quebec government.

As a result, National's shares consistently traded at lower multiples than those of its peers, weighed down as they were by the so-called "Quebec discount." Or, as Mr. Bérard used to call it, the Pepsi factor.

The negativity wasn't baseless. Ever since its creation in 1979, National had a choppy track record and its return on equity was almost always below the industry average. With two-thirds of its business in Quebec, its results reflected the province's slower-growing economy, lower per capita income and the absence of economies of scale.

When it did venture outside the province, the consequences were not often pleasant. In the early 1990s, it lost a bundle on Robert Campeau and the Reichmanns' Olympia & York. It bought Toronto-based First Marathon in 1999 to beef up its presence in investment banking. While the move was a smart one over all, the results have been volatile and the internal politics of integrating a Bay Street renegade into a blueblood French Canadian institution has been sometimes explosive. Meanwhile, the 2002 purchase of mutual fund manager Altamira Investment Services Inc., also Toronto-based, was generally panned by analysts.

So, as Mr. Bérard passed the reins to Mr. Raymond, National's motto as "the first bank of Quebec" was as much an avowal of its failure to successfully diversify its operations outside the province as it was a slogan to lure patriotic Quebeckers.

Flash forward to 2005. Quebec still accounts for 64 per cent of National's revenue. What has allowed Mr. Raymond to turn this concentration into an competitive advantage -- for now, at least -- is focus. The 55-year-old CEO, who started out as a teller in 1970, is single-minded in the pursuit of tangible objectives and has instilled among the bank's almost 17,000 employees a similar culture to succeed. Insiders say morale has rarely been higher.

It no doubt helps that the small-business, mortgage and consumer loans that remain the core of the bank's operations have been generating excellent returns in the past few years, thanks to low interest rates, a buoyant economy and a booming real estate market. None of those factors can be counted on over the next few years. Rates are rising, the high Canadian dollar and oil and gas prices are devastating Quebec's export-driven manufacturers and only the stragglers are still at the property party.

What might just help Mr. Raymond keep the good times rolling is National's alliance with Paul Desmarais' Power Financial Corp. No one much paid attention to the agreement they struck in 2002 whereby the 7,000-member sales force at Power's IGM Financial Inc. and Great-West Lifeco Inc. units (as well as the latter's London Life and Canada Life subsidiaries) pitch certain National products to their clients across Canada. These include RRSP loans, lines of credit and investment loans.

The alliance with Power was slow to yield results and National's disclosure is sketchy. But in fiscal 2005, fully 40 per cent of National's growth in the personal and commercial lending category was derived from business steered through alliances with third parties. By far the most important of these alliances is the one with companies in the Power Financial family. What's more, it gives National access to a revenue stream from outside Quebec without investing in bricks and mortar.

With a situation this advantageous, it's not hard to imagine the Desmaraises and Mr. Raymond doing more deals together.