Monday, June 18, 2007

RBC Capital Markets in the US

The Globe and Mail, Sinclair Stewart & Boyd Erman, 18 June 2007

On a mild evening in late March, 600 business types, including several top officials from Royal Bank of Canada, mingled in a cavernous expanse of New York's Museum of Modern Art, swilling complimentary champagne and munching on Asian tapas.

They had gathered for an exclusive showing of the critically-lauded Vancouver photographer Jeff Wall, whose massive, backlit portraits were the subject of a career retrospective.

But this night was as much a coming-out party for event sponsor RBC Capital Markets, a Canadian investment bank that, after some fitful progress here and more than a few growing pains, had mustered enough swagger to emerge as a cultural patron on arguably this city's grandest stage.

"Tonight, I think, this is one of the first times I can remember that we sponsored an event in the United States that has pretty broad appeal," acknowledged Peter de Vos, a grey-haired former submarine officer who heads RBC's U.S. investment-banking business.

"It's almost like borrowing a line from Avis Rent A Car: We've got to try a little bit harder."

At home in Canada, RBC can rely on brute size, unsurpassed financial muscle, and decades-old relationships to maintain its dominance. In New York? Not so much.

Instead, the bank has had to learn - sometimes the hard way - to hand responsibility to local managers, and resist the temptation to micro-manage from Toronto. It has endured culture clashes and learned to expect mistakes, even failures, as it bought new businesses and expanded into everything from investment banking and trading to fixed income, derivatives, and municipal bonds. And it has learned that things rarely go as planned.

"You have to be patient, and you have to expect it. Believe me, these aren't things that we knew at the beginning," conceded Chuck Winograd, who heads RBC's global capital market business out of Toronto. "Some things haven't become substantial businesses. None of them have worked out exactly. Some have been better, some have been worse, some have taken longer and a few have been shorter. But basically business plans generally take longer."

RBC's New York nerve centre occupies 120,000 square feet in One Liberty Plaza, a hulking black skyscraper just a half-block away from Ground Zero. A swarm of people are hunched over computer screens or bustling about the long corridor of the trading floor, oblivious to the hand-scrawled sign that promises "Blood pressure screening and cookies" - think Wall Street stress with a dash of Canadian nicety.

Soon, many of them will be moving across the street.

The bank's U.S. trading corps has swelled to 500 people, in part from internal growth, and in part because of recent acquisitions like Carlin Financial Group, an electronic trading outfit that caters to small hedge funds.

Space has become an issue, so the bank has quietly arranged to lease another 200,000 square feet at a nearby building this fall.

Of course, the words "expansion" and "United States," at least when they are conjoined, usually conjure a bleak vision for Canadian investors. These investors are all too familiar with the travails of Canadian Imperial Bank of Commerce, which attempted to go toe-to-toe with the biggest U.S. investment banks in the late 1990s, and only ended up stubbing itself. Bank of Montreal has maintained a modest trading and capital markets business here, but that, too, fell prey to the jinx in recent months, amidst a gas-trading scandal that has already cost the bank $680-million (Canadian). And both RBC and Toronto-Dominion Bank have suffered setbacks with their push into U.S. retail banking.

Some of these mistakes have been chalked up to poor timing; others to bad strategy or even arrogance.

Whatever the case, Canada's largest bank has stuck with it, even when things appeared bleak.RBC took a significant step into the U.S. capital markets in 2001, when it paid $2.1-billion to acquire Dain Rauscher and Tucker Anthony Sutro, a pair of Midwestern brokerages. The idea was to create a leading "mid-market" player, catering to smaller companies that weren't viewed as big enough fish for the top Wall Street firms.There were issues from the beginning. On the investment banking front, Dain had a reputation for being "co-manager of choice" - a banking euphemism for bridesmaid. It was in plenty of deals, but only led about one in 10. It also placed a large emphasis on the technology industry, which went into the tank after the dot-com crash. Soon, analysts were griping that RBC had overpaid for Dain.

In the first four years after RBC bought Dain, the investment bank generated just $90-million (Canadian) in profit. After 2004, RBC reorganized its structure, and did not break out specific numbers for its U.S. unit, making it difficult to get a handle on profitability. But there is little debate that the operations are improving.

The U.S. arm now accounts for almost 40 per cent of the company's overall capital markets revenue, and all indications suggest it will surpass Canada soon as the biggest single source. Profit for the global business, meanwhile, climbed to a record $1.4-billion last year, almost double its contribution from 2005 (when the bank suffered from an Enron charge) and well ahead of the $827-million it made in 2004.

Part of the turnaround can be attributed to RBC's recognition that it couldn't oversee the business from Toronto. Six months after it made the Dain purchase in 2001, RBC attempted to integrate its energy and technology businesses into a North American unit, giving some bankers cross-border responsibilities. Then, in 2003, it reversed course, tacitly acknowledging that the markets were far different.

"The game used to be you used to send a Canadian down to do things," Mr. Winograd said. "The fundamental change was recognizing you needed Wall Street people to run it. You could send down the odd Canadian but basically it had to be done with local talent."

It also required new talent. Of the 40 managing partners who worked at the firm when it was acquired, only four are still with RBC.

This is fairly dramatic turnover, and in many ways it has been good. RBC now says it leads about 35 per cent of the deals it is in, and recently won the mandate of sole adviser to specialty grocer Whole Foods Market in its planned $565-million (U.S.) purchase of Wild Oats Market.

Tony Munoz, a young health care services banker who joined this spring from UBS, said he was drawn to RBC because it wasn't a big firm: the clients may be smaller, but that allows bankers to deal directly with more senior executives.

"It's a lot more entrepreneurial here," he said. "Things were sort of cookie-cutter at UBS."

This is precisely the sort of critique an investment banker at an independent Canadian firm might level at RBC's Toronto mother ship. And it brings up an interesting challenge: creating a culture that entices hungry and aggressive young bankers, but at the same time doesn't invite the sort of cowboy theatrics sometimes associated with boutique firms.

"It requires, in my job, I'd say eternal vigilance," said Mr. De Vos. "Do we have to monitor it closely? Do we have to hold up some people's promotions? Yes. And it's hard going through that balancing act."

Taking companies public or advising them on mergers and acquisitions, the business of investment banking, tends to get the headlines.

A great deal of RBC's success resides in the less glamorous worlds of debt and derivatives. Mark Standish, a London native who joined RBC in 1996, oversees both these divisions from his New York office, perched just above the trading floor.

Mr. Standish, recently named co-president of RBC's global capital markets business along with Doug McGregor, who works out of Toronto and heads investment banking, admits it was difficult to get American clients to take his calls initially.

The bank was always strong in municipal bonds, which provide project financing for schools and cities, but less so in the corporate world. He credits a Canadian invention with helping him to bridge the chasm.

Maple bonds, a type of corporate debt sold to Canadian investors by foreign companies, have become a huge business since they were introduced a few years ago, and RBC is the leading player.

"That gave us a really strong calling card," said Mr. Standish. "It suddenly made the Canadian market relevant to a lot of global issuers."

That has helped pave relations not just in the United States, but in Europe as well. The global debt operations, based in London, led $30-billion worth of U.S. dollar issuance in 2005. This year, they're on pace for $80-billion, which would eclipse the entire annual bond sale total in corporate Canada.

In derivatives, RBC is bucking the trend. While some Canadian banks, most notably Toronto-Dominion Bank, have cut back, RBC has bulked up in what is considered one of the more complex - and risky - areas of finance. RBC officials have bristled over suggestions they're climbing the risk curve, and Mr. Standish insists that any fears over the bank's appetite in this regard are misguided.

"I love risk, but I love smart risk," he said. "We can easily up our risk profile."

Mr. Winograd, who prepared for his succession last fall by appointing Mr. Standish and Mr. McGregor as co-presidents, said it's "inexorable" that the U.S. business will become much larger than the Canadian division at some point, but stressed it will do so in a measured and careful fashion. Message? Don't expect any game-changing acquisitions.

"When you take a look at foreign banks in the U.S. that have come and tried to do it, that wanted to do it with a bang, they usually did," he said. "I always say I wish I knew as much as I knew now when I started, because it would have been easier. Some of my lessons in this business have been very expensive."