How Blocked Mergers Foiled Banks' Ambitions — and Forced the Big Six to Innovate

The Globe and Mail, James Bradshaw, 25 December 2018

When Royal Bank of Canada and Bank of Montreal announced a surprise plan to merge on Jan. 23, 1998, the news landed like a bombshell. By the time then-finance minister Paul Martin dashed their hopes less than a year later, the notion of mega-bank mergers had turned radioactive.

It was 20 years ago, on Dec. 14, 1998, when Mr. Martin turned down RBC and BMO’s plan, as well as a subsequent tie-up proposed by Canadian Imperial Bank of Commerce and Toronto-Dominion Bank. His ruling stamped big bank mergers as politically untouchable in Canada, and that imprint is still clearly visible today.

The mergers, had they been allowed, would have dramatically reshaped Canada’s banking sector, condensing an already cozy industry while setting the combined banks on a fast track to extend their influence in the rapidly consolidating U.S. banking market.

“It became pretty obvious that nobody other than the banks thought it was a good idea,” says Charles Baillie, who was chief executive officer of TD at the time, in an interview.

Instead, after a hard-fought public campaign lasting 11 months, each bank was forced to resort to its own plan B, with varying success. With diverging strategies, Canada’s leading banks carved out more distinctive identities over the next two decades, some gaining influence while others lost ground.

The agreement that set the merger debate in motion famously came to life over eggnog and hors d’oeuvres at BMO’s Christmas party on the 68th floor of its Toronto offices, late in 1997. John Cleghorn, who was RBC’s chief executive, crashed the party to bend the ear of his BMO counterpart, Matthew Barrett.

Their tête-à-tête was only one of a series of merger talks leaders from several of Canada’s largest banks had quietly held with each other in the late 1990s. A wave of consolidation among U.S. and European banks made Canadian executives wary that they would be vulnerable on their own turf if they didn’t get bigger and improve their clout abroad. Mr. Barrett warned that Canadian banks risked ending up like “the corner hardware store waiting for Home Depot to arrive to put it out of business."

Mr. Cleghorn, as the leader of the country’s largest bank, felt strongly that RBC needed to be first out of the gate. After a month of intense negotiations, a deal was struck late on the evening of Jan. 22. But it wasn’t until the next morning that the banks tried to give Mr. Martin a heads up.

At the time, lawyer Harold MacKay was leading a federal task force that was in the midst of drafting a report on the future of financial institutions. Mr. Martin, who has not been in favour of the mergers from the start, says the banks should have waited for the report.

Internally, the banks debated how far in advance they should make Mr. Martin aware of such a blockbuster deal, given that he would be its arbiter. There were legal concerns to consider, but also fears that Mr. Martin or prime minister Jean Chrétien – who also instinctively opposed the mergers – might shut the plan down before it ever got started.

“If we had not tried, we would not have found out what the rules were going to be – there were no rules,” Mr. Cleghorn says.

Once the merger was announced, bankers felt there was a chance they could win public support – which proved to be a fatal miscalculation. “It landed like a lead balloon in the court of public opinion,” says Konrad von Finckenstein, who was commissioner of the Competition Bureau, tasked with examining the merger’s impact.

When CIBC and TD announced their own merger agreement in April, 1998, the odds of either deal winning federal approval only grew more remote. “We weren’t that optimistic that we’d be able to pull it off, but we thought defensively, we can’t afford to have the Royal and the Montreal combine and be that much larger,” Mr. Baillie says.

That other banks would feel pressure to follow suit “was entirely predictable,” Mr. Martin says. What proved harder to anticipate was the strength of the backlash. Small businesses, in particular, feared they would be left with fewer options, and Mr. Martin confirms that “the business community was not in favour, by and large.”

In the early going, the banks' own arguments for the deal’s merits weren’t helping. Mr. von Finckenstein remembers receiving separate visits from Mr. Cleghorn and Mr. Barrett, each making the case it was “blindingly obvious” that a merger would make for a more efficient banking system and benefit shareholders. “I remember going away from them saying, ‘You never mentioned your customers,’" Mr. von Finckenstein says.

It wasn’t until the later stages of the campaign that the two banks began making public pledges about preserving bank branches, catering to small businesses, freezing some service charges and finding new roles for employees whose jobs would be displaced. But this came too late, says David Moorcroft, who was RBC’s vice-president of public affairs. “I think we were fighting a rearguard action then.”

The final blow came when the Competition Bureau released a damning report detailing ways the mergers would diminish competition in banking, from access for small businesses to credit-card concentration. Some concerns could have been addressed, but that would have required major divestitures – for instance, the Competition Bureau would not have allowed RBC and BMO’s investment banking arms, Dominion Securities Inc. and Nesbitt Burns Inc., to join together.

Mr. Martin welcomed input from the Bureau. “He needed something to justify turning it down,” Mr. von Finckenstein says. “He was inclined to do it but he needed the ammunition, and we presented him with the ammunition.”

Some bankers were angry when Mr. Martin killed the mergers, but their bitterness faded over time.

“[Mr. Martin] had to do what he had to do, and I was trying to do what I had to do. We all moved on. But we also knew what the score was," Mr. Cleghorn says.

Discussions about mergers carried on in the background for years, and BMO even took a second run at a merger in 2002, this time with Bank of Nova Scotia, which had been vocally opposed to mergers in 1998 when it was unable to find a dance partner. But the banks failed to win a blessing from new finance minister John Manley, and abandoned the plan.

At TD, a backup plan was already in motion. In advance of Mr. Martin announcing his decision in late 1998, he called bank CEOs to Ottawa to brief them. Mr. Baillie hitched a ride to Ottawa on CIBC CEO Al Flood’s plane, and on the flight, said to him, "'Well, it looks like we’re competitors again, so you might want five minutes alone with the finance minister, and I’d like to have five minutes alone with him.’ So we agreed to that.”

Mr. Baillie says he used his five minutes to test Mr. Martin’s willingness to allow TD to acquire Canada Trust, a major force in retail banking that had attracted takeover interest from several lenders. Mr. Martin’s response, as Mr. Baillie recalls, was “as long is it isn’t one of the [Big Five banks]." Mr. Martin says he doesn’t remember that exchange.

In no time, TD was on the phone with the largest shareholders in Imasco Ltd., which owned Canada Trust. In 2000, TD struck a deal, pulling off a coup that helped transform what was then Canada’s fifth-largest lender. TD is now neck and neck with RBC for the title of Canada’s largest bank, with $1.3-trillion in assets.

“I think if [the mergers of 1998] had gone through, we would not have had a competitive advantage vis-à-vis the Royal and the Montreal,” Mr. Baillie says. “From TD’s point of view, it couldn’t have worked out better.”

Other banks took longer to regroup. RBC ultimately bought North Carolina-based Centura Bank in 2001, then sold it in 2011 after struggling to gain traction in American retail banking, though it also built a New York-based capital markets arm that now ranks among the top 10 U.S. investment banks. CIBC, which was Canada’s second-largest bank at the time of the mergers, plunged aggressively into ill-fated forays in U.S. investment banking and electronic retail banking that led to massive write-downs. Over time, CIBC fell to fifth place among Canada’s largest banks, and only recently re-established its U.S. footprint with a commercial and private bank based in Chicago. BMO gradually built its strength in commercial and retail banking in the U.S. Midwest through BMO Harris Bank, which it had already acquired in 1984. And Scotiabank largely bypassed the United States, investing instead in more emerging markets such as Latin America and the Caribbean.

"The biggest lasting impact [of the blocked bank mergers] is that Canadian banks had to be more innovative about how they would continue to grow,” Mr. Moorcroft says. “Before that, the strategies of the big banks were pretty similar.”

The fallout was tangible in other important ways. Discussions over mergers between the government, regulators and the Bank of Canada shaped concerns about banks becoming too big to fail – a problem that came into sharp focus in 2008 with the onset of a global financial crisis. Canadian banks were still building their U.S. footprints and had avoided many of the worst excesses of their peers abroad, seizing the opportunity to snatch up talent cut loose by floundering U.S. banks.

Denying the mergers may also have strengthened the hand of Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), in restraining the banks. “I’m sure OSFI was under tremendous pressure to loosen the reins and allow all sorts of things that were happening in the States,” Mr. von Finckenstein says. “If we had had even larger entities, and fewer, it would have been so much harder for them to resist the pressure.”

Today, there is broad agreement that a merger between any of Canada’s largest banks is still verboten, no matter the government of the day, except in a crisis in which a major Canadian bank would need rescuing. “I think all you could do is lose votes if you supported it,” Mr. Baillie says.

Then again, Mr. Cleghorn says, “you never say never.”

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Banks Made $45.3-billion in 2018. Who’s Shining Brightest?

The Globe and Mail, David Berman, 11 December 2018

Fans of Canadian bank stocks will appreciate this number: $45.3-billion.

That’s the total profit generated by the Big Six banks in fiscal 2018 (which ended Oct. 31), and the gargantuan number reinforces why the banks have been delivering stellar gains and rising dividends over the long term.

Buying all six bank stocks and holding on during rallies and downturns makes a lot of sense. But it’s also worth taking a closer look at their individual performances to gain an understanding of which bank is leading the way. Here are a number of ways to slice and dice their financial results.

• BIGGEST PROFIT GAIN, 2018: TD

The Big Six banks’ fourth-quarter results can be summarized like this: Profits went up by an average of 13 per cent year-over-year, and share prices went down.

Toronto-Dominion Bank is the quarterly winner, in terms of its year-over-year adjusted profit (which ignores some one-time items): TD reported a gain of 20 per cent, which analysts described as solid, even as they expressed some caution over the bank’s rising expenses. Bank of Montreal was a close second, with 19-per-cent growth, followed by Royal Bank of Canada at 16 per cent.

For the full fiscal year, TD is also the profit powerhouse. Its 2018 adjusted profit, on a per-share basis, increased 16.8 per cent from 2017.

Not so keen on these adjustments? If you look at net earnings, which can move with taxes, divestitures and acquisitions, Canadian Imperial Bank of Commerce wins with a gain of 11.4 per cent.

• BEST “BEAT” RATE, 2018: CIBC

During earnings season, stocks can be judged by how they live up to analysts’ expectations. In their fourth quarter, Big Six banks delivered adjusted earnings that were remarkably close to expectations: They surpassed the consensus by 1 per cent, on average.

RBC had the biggest beat rate, at 5.7 per cent. Over the full year, though, RBC was in the middle of the pack, with an average beat rate of 3.3 per cent over four quarters. TD did better, with an average beat rate of 4.6 per cent. CIBC tops them all with an average beat rate of 5.4 per cent.

• BEST DIVIDEND GROWTH, 2018: TD

If you look strictly at indicated dividend yields, then CIBC is the winner here: Its 5.1 per cent yield – based on its latest distribution and helped by a declining share price and rising quarterly payout – is the best of the bunch.

However, many longer-term investors appreciate banks that raise their quarterly payouts at a faster pace. Looked at from this perspective, Toronto-Dominion Bank is the winner. TD raised its payout by a dazzling 11.7 per cent in fiscal 2018 – well more than CIBC’s 4.6-per-cent dividend hike for the full year and the 7.9 per cent average among the Big Six banks.

This may explain why TD’s dividend yield is the lowest of the group: At just 3.85 per cent, the yield implies expectations for brisk growth.

• HIGHEST CET1 RATIO: TD

This sounds a bit wonkish, but bear with us. The Common Equity Tier 1 ratio is a measure of capital that is watched by regulators to ensure that a bank can withstand a downturn. A higher ratio means that a bank has a bigger buffer, and the bank can lower it by buying back shares or making deals when times are good.

TD is the winner here, with a CET1 ratio of 12 per cent. That’s not only the highest among the Big Six; it also represents the biggest year-over-year gain, at 1.3 percentage points. There is a downside here: A high ratio means that more capital is sidelined rather than making profit – but a bit of fat might be just the thing if the market is worried about the economy.

• BEST STOCK PERFORMANCE: TD

Bank stocks have been struggling this year, and many observers are puzzled. Maybe, part of the problem is that the overall stock market has turned volatile. Then there’s also rising borrowing costs, indebted consumers, tumbling oil prices and concerns about Canada’s housing market.

The Big Six stocks are down an average of 9.4 per cent since the start of January, not including dividends. Canadian Imperial Bank of Commerce has fared the worst, falling 13.9 per cent. Toronto-Dominion Bank has performed best, but its decline of 5.8 per cent is not going to inspire celebrations.

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Banks Brush Off Oil-Price Crash

The Globe and Mail, Tim Kiladze & Alexandra Posadzki, 9 December 2018

Canada’s largest banks are brushing off the recent crash in domestic-crude prices, confident that their loan books are in solid shape.

Collectively, the Big Six banks reported $45-billion in annual profits for fiscal 2018, which ended on Oct 31. Yet on recent conference calls to discuss their fourth-quarter earnings, analysts pressed executives for details about their loan exposures to oil and gas companies, worried that a crisis could be brewing behind the scenes, resulting in large write-downs.

All six banks responded in the same fashion: This is not 2016. There was barely a crisis for them then, and there definitely isn’t one now.

“Since 2015 and 2016, we’ve ‘up-tiered’ the companies we deal with,” Dieter Jentsch, head of global banking and markets at Bank of Nova Scotia, said on a conference call. “And I have to say to you that the balance sheets that we see in the business have never been as strong, and the management teams are very cost-conscious.”

When the global price of crude plummeted below US$30 per barrel in early February, 2016, some analysts and investors worried. At the time, about 80 per cent of Royal Bank of Canada’s outstanding energy loans were made to non-investment-grade companies, while National Bank of Canada had large loan exposures to junior oil and gas companies.

Ultimately, the banks emerged relatively unscathed. But to be safe, a number have taken steps to protect themselves. National Bank chief risk officer Bill Bonnell said on a conference call that the bank’s oil and gas loan portfolio has been “meaningfully rebalanced since 2015,” adding that its outstanding loans in the energy sector “have been brought down significantly.”

As a percentage of its total loan portfolio, National Bank has cut its energy exposure in half over the past three years. Oil and gas now makes up 1.7 per cent of its total loan book, down from 3.6 per cent at the peak in 2015.

But Canada’s banks have not cut ties with energy companies en masse. In fact, total loan exposure to the sector across the Big Six hit $47-billion at the end of fiscal 2018, up 4.8 per cent from $44.9-billion three years prior.

That statistic might raise concerns among bank investors because crude prices are volatile again. In October, Western Canadian Select, a benchmark for Alberta heavy oil, sold at a discount to West Texas intermediate oil of some US$50 - more than double the historical average. (That discount had shrunk to only US$15 on Friday after Alberta Premier Rachel Notley enforced production cuts on the province’s oil sands producers.)

Canada’s banks are not fazed. And outsiders appreciate why.

To start, the energy sector isn’t in need of as much debt. “There’s generally less investment going on in the oil patch,” David Beattie, credit analyst at Moody’s Investors Service, said in an interview. Just last week, oil sands giant Canadian Natural Resources cut its 2019 capital spending by $1-billion to $3.7-billion.

Energy loans as a percentage of the Big Six banks’ total portfolios have fallen over three years. Oil and gas lending has climbed 4.7 per cent, but total lending has jumped 22.5 per cent.

Canada’s banks have also cut their exposures to riskier junior oil and gas companies. National Bank’s Mr. Bonnell said on a conference call that its energy relationships "have been refocused on larger, well-capitalized oil and gas producers and deepened with large investment-grade pipeline clients,”

But rivals have, too, and often it happened simply because smaller producers have been disappearing. “There’s been a number of mergers and takeovers, and a number of companies have just gone under,” Raymond James energy analyst Jeremy McCrea said in an interview.

Since the start of 2015, 160 North American energy companies have filed for bankruptcy, according to Haynes and Boone LLP. Of these, 18 were Canadian, the largest of which was Endurance Energy Ltd., which had US$475-million in debt.

Market dynamics have played a role too, diverting loans away from riskier junior companies. Many junior energy companies were financed through reserve-based lending, and under this model, banks use a company’s oil and gas reserves as collateral.

“As oil prices (especially WCS) have declined, the value of the reserves decreased, as did the size of the bank lines [of credit]," Ravikanth Rai, a credit analyst at DBRS Ltd., wrote in an e-mail. “This forced the companies to deleverage as opposed to the banks having an active strategy to reduce exposure to the sector.”

And then there is the recent move in WCS prices, which narrowed the discount to WTI.

The banks, of course, are not completely out of the woods. Energy prices are inherently volatile, and trade tensions between the United States and China are rising, hurting the global economic outlook.

But the odds are in the banks' favour. Since the 2008 global financial crisis they have continually added capital cushions to absorb loan losses, and those levels today are the highest they have ever been.

Their exposure to the sector has also fallen dramatically over three decades. When energy prices plummeted in the late 1980s, oil and gas producers made up 7 per cent of total bank loans. By 2016, they were 2 per cent of the collective portfolio. Today, they are 1.7 per cent.

“Though the market never believes the banks when they say their exposures are manageable, the numbers clearly demonstrate that the sector has become more adept at credit risk management over time," Scotiabank financial services analyst Sumit Malhotra wrote in an e-mail.

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BMO Q4 2018 Earnings

The Globe and Mail, Tim Kiladze, 4 December 2018

Bank of Montreal’s personal and commercial banking profits surged in the United States over the past fiscal year, but the uncertainty of a repeat performance is clouding the lender’s outlook.

Similar to rivals Toronto-Dominion Bank and Canadian Imperial Bank of Commerce, BMO operates a sizable bank in the United States that focuses on traditional lending. After years of underwhelming earnings, the Chicago-based unit saw profits jump 35 per cent, to $1.4-billion, in the fiscal year that ended Oct. 31.

On the back of this performance, BMO is making U.S. banking a crucial element of the growth story it is telling investors. “The U.S. segment remains a priority where we’ll continue to grow earnings at a faster pace than the overall bank," chief executive Darryl White said on a conference call Tuesday after reporting a fourth-quarter profit of $1.7-billion.

For the full year, the bank earned $5.45-billion, with the U.S. division contributing 26 per cent of that.

The trouble, however, is that the competitive landscape in the United States is changing. Both TD and CIBC noted last week that a battle for loans and deposits is escalating – and it is likely to dent lending margins. BMO’s U.S. head, David Casper, said on a conference call that there is likely to be “modest downward pressure” on lending margins because of such competition.

The current dynamic has changed the outlook in that market. Because the economic recovery from the 2008 financial crisis was painstakingly slow, there was hope across the industry that rising rates would eventually boost bottom lines. While such gains have materialized of late, with lending margins rising, banks are starting to pay more for the deposits that fund their loans. “We expect to pass along higher rates to our customers,” Mr. Casper said of the coming year.

There are also signs in the bond market that the near-decade of U.S. economic expansion could finally be coming to an end – or is at least cooling. The change in expectations hit bank stocks Tuesday, with shares of the four largest U.S. banks dropping an average of 4.7 per cent. BMO shares fell 3.8 per cent.

While BMO’s U.S. P&C bank is only one division of four, its outlook is important because earnings from the Canadian equivalent barely rose in fiscal 2018 and BMO’s capital markets profit has been relatively flat for two straight years.

Wealth management has been a bright spot, with profit from traditional wealth – excluding insurance – climbing 10 per cent in fiscal 2018, but a recent bout of market volatility has dimmed near-term earnings growth, division head Joanna Rotenberg said on the conference call.

“Although we continue to rate BMO favourably over the longer term, several guidance items point to a softer start to fiscal 2019,” National Bank Financial analyst Gabriel Dechaine wrote in a research report, citing U.S. lending margins and wealth-management profits among his reasons.

Despite the short-term uncertainty, commercial lending has continued to be a bright spot for BMO. The bank’s roots in business lending have paid dividends because loan growth in that market is booming. In Canada, total personal and commercial loans climbed 4 per cent in fiscal 2018, but commercial loans jumped 12 per cent; in the United States, commercial loans rose 10 per cent and commercial deposits spiked 16 per cent.

“We had double-digit loan growth in both Canada and in the United States, as well as good deposit growth,” Mr. White said of BMO’s commercial division on the conference call, adding that the growth “is well diversified across sectors and geographies consistent with our approach to building our business within our risk appetite.”

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CIBC & TD Bank Q4 2018 Earnings

The Globe and Mail, Tim Kiladze, 29 November 2018

Toronto-Dominion Bank and Canadian Imperial Bank of Commerce can thank a hot U.S. economy for higher profits. But the banks' sizable American operations aren’t expected to deliver as much growth in 2019 because of rising competition.

TD and CIBC, which both released year-end earnings on Thursday, have a lot of exposure to the United States following large acquisitions. Lately, profit growth from those divisions has been encouraging – particularly for TD. The bank, which endured years of anemic returns in its U.S personal and commercial bank after the global financial crisis, saw its annual profit from U.S. retail banking jump 26 per cent to $4.2-billion.

Oddly enough, the worry now is that the U.S. economy has been doing too well. The recovery is nearly a decade old and inflation and wages are ticking higher, prompting the Federal Reserve to hike interest rates eight times in the past two years.

Because business is booming, the U.S. banking market has become extremely competitive. “Competition has increased,” DBRS Ltd. analyst Robert Colangelo said. "Even though the U.S. is a very large market, it is limited in how much market share the banks can take – especially on the commercial side.”

Executives from both banks echoed this sentiment in conference calls Thursday. “It certainly has been competitive" when luring commercial deposits, said Greg Braca, group head of U.S. banking at TD.

“We’ve reached a threshold,” said Larry Richman, head of the U.S. region for CIBC. “As rates are rising, clients that have excess cash are wanting to get paid for it.”

Retail and commercial banks make money by attracting low-cost deposits and lending this money out at higher rates. Lately, U.S. banks have been able to charge more per loan, because interest rates have been rising.

But the market for attracting deposits is also getting more aggressive, which will force banks to pay up for deposits, slowing their loan margin growth.

A few more clouds are also forming over the U.S. economy. In a report released Thursday, credit rating agency Standard & Poor’s noted “the risk of recession for the U.S. has risen and growth will likely slow even if the U.S.-China tariff dispute doesn’t escalate into a trade war.”

S&P said the odds of a downturn over the next 12 months are 15 per cent to 20 per cent, compared with 10 per cent to 15 per cent in its previous forecast.

Despite shifts in the United States, total earnings at both banks are still expected to be higher next year. TD is particularly optimistic, with chief executive Bharat Masrani predicting total earnings growth of 7 per cent to 10 per cent in fiscal 2019.

CIBC is slightly less bullish, expecting 5-per-cent to 10-per-cent expansion. However, the bank remains optimistic about the quality of its loan book. “While there continue to be potential headwinds, as it feels like we are entering the later part of the economic cycle, we remain confident in our strong underwriting practices and the quality of our credit portfolios,” chief risk officer Laura Dottori-Attanasio said in a conference call.

Investors had divergent reactions to the profits announced Thursday. TD’s shares were relatively flat by the end of the trading day, closing at $73.48, while CIBC’s shares fell 3 per cent to $112.46.

For the full fiscal year, which ended Oct. 31, TD reported net income of $11.3-billion, nearly 8 per cent higher than fiscal 2017, while CIBC’s annual profit climbed to $5.2-billion, up 12 per cent from the prior year.

Earlier this week, TD and CIBC announced the details of their participation in Air Canada’s acquisition of the Aeroplan loyalty rewards program. TD is betting heavily on Aeroplan, committing to $1-billion worth of upfront payments and future expenses as the lead financial partner. Its contract with Air Canada will start in 2020 and last until 2030.

CIBC will be a secondary partner in the new arrangement, and has agreed to pay $292-million in total to participate.

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RBC Q4 2018 Earnings

The Globe and Mail, Tim Kiladze, 28 November 2018

Royal Bank of Canada reported solid profits on Wednesday for the ninth straight year, and, like clockwork, the bank’s executives were rewarded with skeptical questions from analysts about the odds of future success.

Such scrutiny is almost automatic for Canada’s largest public company by stock-market value. Canadian banks have faced one obstacle after another over the past decade. There was the financial crisis, the slow economic recovery, the fears of a housing bubble, the collapse of energy prices from 2014 to 2016. Now, the price of Alberta heavy oil is tumbling again.

But through it all, the country’s biggest banks have remained sturdy – and RBC has been one of the most dependable. Its total profit in fiscal 2018, which ended Oct. 31, hit $12.4-billion. That’s 38 per cent higher than the earnings announced five years before.

For all that growth, RBC can’t shake the questions about its resilience. Before Wednesday, its shares had fallen 4.9 per cent in the past 12 months, despite delivering better earnings in each consecutive quarter over the past year.

The latest results did persuade buyers to push the stock the stock 2.7 per cent higher on Wednesday, to $98.10. But the broader market also rose sharply. Winning over investors is expected to remain tough.

“The market is pricing in substantial headwinds for 2019,” Eight Capital analyst Steve Theriault wrote in a research report on Wednesday. RBC’s stock trades at less than 12 times last year’s earnings.

What is the root of the market’s skepticism? On top of regular hiccups such as commodity price swings, which threaten to bring higher loan losses in Alberta, the 2008 crash still lingers in some investors' minds. There have been continuous political, economic and market disruptions in the decade since – everything from the unexpected election of U.S. President Donald Trump to the quantitative easing that lasted longer than many thought it would and suppressed interest rates.

Still, by now, RBC’s continued strength is tough to overlook. On Wednesday, the bank reported that its Tier 1 capital ratio is 11.5 per cent, a full percentage point higher than RBC’s target level, and much higher than it was before the financial crisis. That means the bank has loads of money tucked away to serve as a buffer when a downturn comes.

RBC’s return on equity, one of the industry’s most closely watched metrics, also sits at 17.6 per cent. To put that in perspective, JP Morgan Chase & Co. is constantly praised as one of the world’s best-run banks, but its ROE is 14 per cent.

This return largely stems from a stellar personal and commercial banking (P&C) business that contributes nearly 50 per cent of RBC’s bottom line. The division remains highly profitable, despite a recent housing slowdown. In fiscal 2018, the bank’s residential mortgage portfolio grew 5 per cent, but total P&C revenues rose 8.6 per cent in the fourth quarter, compared with the previous year.

“Companies are investing. Employment is strong. There are a number of tailwinds from an economic perspective," chief financial officer Rod Bolger said in an interview.

The strong economy means interest rates are rising at last, and that has been a major boon to lenders, allowing them to charge more for mortgages and many other loans. The rates banks pay on deposits are also rising, but not as quickly.

Of course, nothing lasts forever, and lately there are growing expectations of a U.S. recession, or at least a sharp slowdown. Asked about the largest systemic threats that RBC faces, Mr. Bolger, the CFO, cited trade tensions and the risk of higher unemployment. At the moment, this threat is most imminent in Alberta, because the province is wrestling with low prices for oil and gas.

As for RBC’s own oil and gas exposure, chief risk officer Graeme Hepworth brushed off the questions on Wednesday, noting that the sector amounts to only 1 per cent of RBC’s total loan book and calling the risk “pretty small, pretty manageable.”

RBC must also demonstrate that its U.S. City National division will deliver better profits. The bank has invested in it this year, and that has taken the steam out of profit expansion. The American market dynamics are also changing, with many affluent and high-net-worth clients moving their money out of deposits and into better-yielding assets, which makes it harder for banks such as City National to find cheaper ways of funding their loans.

RBC’s executives, though, are not sweating it. “We’re feeling good about the outlook for the economy and for the bank," chief executive officer Dave McKay said on a conference call on Wednesday.

Investors that trust them could see big gains. “If RBC can in fact deliver, we believe there is meaningful upside for [its] shares as the bank continues to do a lot of the right things," Mr. Theriault, the analyst, said in his report.

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Scotiabank Q4 2018 Earnings

The Globe and Mail, Tim Kiladze, 27 November 2018

Bank of Nova Scotia signalled that it will take a breather from major acquisitions, after racking up deals totalling nearly $7-billion over the past year.

Chief executive Brian Porter said the focal point in 2019 will be on merging these purchases into the bank’s existing operation instead of seeking out new acquisitions. At the same time, Scotiabank continues to prune divisions that it considers “non-core,” or those that are not crucial to its future, disclosing Tuesday that it’s selling its banking operations in nine Caribbean countries as well as its life insurance businesses in Jamaica and Trinidad.

“This year is going to be focused on integration,” Mr. Porter said on a conference call. “We’re not in the business of acquiring anything this year.”

Mr. Porter has been refining the bank’s business mix since he took over five years ago and has exited, or announced a plan to exit, 22 businesses or geographic markets in that time. Mr. Porter told investors to expect more divestitures in the next year, though he did not provide specific targets. Analysts expect Scotiabank to sell its 49-per-cent stake in Thailand’s Thanachart Bank, something that has long been rumoured.

The bank’s move to slow down on acquisitions follows some investor concern about the pace of deals and the bank’s ability to generate good returns on them. Over the past 12 months, Scotiabank has announced three sizable acquisitions, the largest of which was the majority stake in Banco Bilbao Vizcaya Argentaria S.A.'s retail banking business in Chile, for a cost of $2.9-billion. Other notable deals included snapping up money managers MD Financial Management and Jarislowsky Fraser Ltd., two separate acquisitions that cost the bank a total of more than $3.5-billion.

Individually, each deal was in line with business goals that Scotiabank had previously spelled out. Collectively, however, they made investors pause. Concerns about Scotiabank’s ability to extract good acquisition returns, coupled with some fears about economic weakness in emerging markets and some tremors from North American free-trade negotiations, have weighed on Scotiabank’s share price, which has overshadowed the bank’s solid earnings growth of 10 per cent in the past 12 months, after adjusting for one-time costs incurred in 2018.

Since Nov. 1, 2017, which was the start of the previous fiscal year, Scotiabank’s shares have dropped about 15 per cent. The average performance of the five other large Canadian banks over the same period is a drop of about 2 per cent.​

“After having deployed $7-billion on acquisitions over the past year, Scotiabank has (rightfully) shifted its strategic focus to integration and execution," National Bank Financial analyst Gabriel Dechaine wrote in a research note. “While we normally view this type of commentary as predictable, in Scotiabank’s case, execution on M&A [mergers and acquisitions] integration is of utmost importance.”

While some investors have been down on the bank, the lender’s profit continues to climb, particularly in Canadian banking, which contributes 50 per cent of total earnings. Despite a recent slowdown in housing sales, Scotiabank’s average mortgage portfolio grew 3 per cent year-over-year, and the lender expects residential mortgages to continue growing at around 4 per cent next year.

Projected interest rate hikes by the Bank of Canada are also likely to boost profits, because banks will be able to issue loans at higher yields. Meanwhile, the deposits that fund these loans take longer to re-price to higher rates, boosting their lending margins. Scotiabank expects total profit from Canadian banking to climb 7 per cent or higher in 2019.

Earnings also jumped in the international banking unit, which is now dominated by Latin America – and particularly by what Scotiabank calls the “Pacific Alliance” countries of Chile, Colombia, Peru and Mexico. The division’s total profit climbed 17 per cent in 2018, after adjusting for one-time items. While this surge was boosted by the recent BBVA Chile acquisition, even after stripping this addition out, profit still jumped 15 per cent.

The news Tuesday that Scotiabank is exiting nine small Caribbean countries and selling the operations to Republic Bank comes as much of the region struggles to deliver consistent economic growth – a problem that has also affected Royal Bank of Canada and Canadian Imperial Bank of Commerce. RBC recently sold its Jamaican operations, and earlier this year CIBC tried to sell off some of its FirstCaribbean bank by taking it public in the United States, but ultimately had to pull the deal.

“Due to increasing regulatory complexity and the need for continued investment in technology to support our regulatory requirements, we made the decision to focus the bank’s efforts on those markets with significant scale in which we can make the greatest difference for our customers,” Scotiabank said in a statement.

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The Globe and Mail, David Berman, 27 November 2018

You might be tempted to invest in Bank of Nova Scotia because of its big dividend yield, low valuation or large emerging-markets footprint. But here’s a better reason: The stock is a dud.

The share price has slumped 13.5 per cent so far in 2018, making it the worst-performing stock among Canada’s five biggest banks. It has underperformed its peers by 7.2 percentage points (not including dividends). And the stock has trailed the year’s best performer, Toronto-Dominion Bank, by 11.3 percentage points.

Scotiabank’s fiscal fourth-quarter earnings report, released on Tuesday morning, didn’t help the situation. The bank missed analysts' earnings expectations by 2 cents – it reported a profit of $1.77 a share, after adjustments, versus an expectation of $1.79 a share. Although the share price rose 0.1 per cent to $70.15, Scotiabank trailed its four biggest peers.

So why warm to a cold bank?

The answer lies in a simple stock-picking strategy: Since lagging banks have an impressive track record of catching up with their big-bank peers relatively quickly, investors can score market-beating gains by scooping them up.

We’ve been tracking this strategy using data going back to 2000. Buying the prior year’s worst-performing bank stock and holding it for one year has produced an average annual return of 17 per cent (not including dividends).

That’s better than the 11-per-cent average return you would get from holding all of the biggest five bank stocks over the same period. And it’s much better than the 5-per-cent average return for the S&P/TSX Composite Index.

The strategy has delivered peer-beating returns 69 per cent of the time, and it has beaten the broad index 75 per cent of the time, which is a compelling record.

Although buying Scotiabank in 2015 was the most recent misfire (the stock trailed its peers by 5 percentage points that year), the strategy has worked well in the past few years. Buying Scotiabank again in 2016 and Canadian Imperial Bank of Commerce in 2017 produced peer-beating returns.

This year looks good too, relatively speaking. Yes, Bank of Montreal, last year’s laggard and this year’s pick, is down 2.6 per cent year-to-date. But the stock is outperforming its peers by 3.7 percentage points and is beating the S&P/TSX Composite Index by more than 5 percentage points.

Indeed, BMO is the second-best bank stock this year, and it is just 0.4 percentage points behind first-place TD.

Which brings us back to Scotiabank. The stock looks set to end the year as the laggard in 2018 and the top pick for 2019, making the list for the third time in five years.

All Canadian bank stocks have been struggling this year for a number of reasons. Rising interest rates are making bonds look more attractive next to dividend-paying stocks, the mortgage market is slowing, and low oil prices are threatening the Canadian economy and raising questions about whether bank loans to the energy sector will be repaid in full.

As well, Scotiabank has issues of its own. The bank has considerable exposure to Mexico, Colombia, Chile and Peru, but emerging markets have fallen out of favour with investors this year amid concerns over trade tariffs, falling commodity prices and rising U.S. interest rates.

More importantly, the bank has been on a $7-billion acquisition binge over the past 12 months – including its US$2.2-billion deal for BBVA Chile last November, when Scotiabank’s share price was near a record high. The weaker share price since then may be reflecting concerns over whether its acquisitions will pay off.

Betting on successful integration is a tough one for most investors to get right. Add to that the complexities of commodity prices, monetary policy and – most problematic of all – a coherent trade strategy from the U.S. White House, and you can be forgiven for nursing some uncertainty over bank stocks.

But Scotiabank shares now yield more than 4.8 per cent, the highest dividend payout of the biggest five banks. And they trade at just 9.5-times estimated earnings, according to Bloomberg, which is a cheaper valuation than all but CIBC.

Put another way, there is a wide gap between Scotiabank and its peers. Over the next year, the bank will probably close it.

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Analysts Offer Mixed Outlook on Big Six Q42018 Results

The Globe and Mail, David Berman, 25 November 2018

Canada’s biggest banks will report their fiscal fourth quarter results starting this week, and analysts are expecting a strong finish to the year. But given the stock market is dominated by concerns over slowing economic activity, will investors care?

Bank of Nova Scotia will kick off the reporting on Tuesday, followed by Royal Bank of Canada on Wednesday and Canadian Imperial Bank of Commerce and Toronto-Dominion Bank on Thursday.

Next week, Bank of Montreal and National Bank of Canada will report their results on Dec. 4 and 5, respectively, for the three-month period ended Oct. 31.

Analysts anticipate the Big Six banks will show profit growth of about 12 per cent, year-over-year, driven by their strong international operations, accelerating commercial loan growth and rising interest income. They also expect BMO and National Bank will raise their dividends.

“It has been a good year. Moreover, notwithstanding the share price performance in the last few months, commentary at recent conferences and investor days suggests that fiscal 2019 will be another good one,” Robert Sedran, an analyst at CIBC World Markets, said in a note.

But the quarterly results will arrive during an unsettled period for the stock market. Investors are focusing on the threat of trade tariffs, inflationary pressures and rising interest rates, which is causing wild swings by major indexes. In Canada, higher borrowing costs are weighing on the housing market, which is also adjusting to tighter lending regulations, and low oil prices are hitting the energy sector.

The S&P/TSX Composite Index is down 7.4 per cent this year. Although bank stocks are outperforming the broad index, ever-so-slightly, no one is cheering: The S&P/TSX Commercial Banks Index is down 6.9 per cent this year after taking a 9.5-per-cent nosedive since September.

Will fourth quarter results lift the mood? Analysts expect TD, BMO, RBC and CIBC will benefit from their U.S. divisions, where profits are being driven by recent tax cuts and strong economic activity, and they expect Scotiabank’s profits will get a lift from the bank’s recent acquisition in Chile.

Together, profits from the banks’ U.S. and international operations should rise 31 per cent over last year, according to Sohrab Movahedi, an analyst at BMO Nesbitt Burns.

But expectations for Canadian personal and commercial banking – the meat and potatoes of bank operations – are far more muted. Darko Mihelic, an analyst at RBC Dominion Securities, pegs fourth quarter P&C growth at 3 per cent, year-over-year.

“We maintain our view that Canadian consumer loan growth is likely to slow in an environment of slower GDP [gross domestic product] growth and rising interest rates given the relatively high level of consumer indebtedness," Mr. Mihelic said in a note. "We are of the view that this will ultimately lead to slower net interest income and total revenue growth over the next few years.”

Residential mortgage growth in Canada slowed to just 3 per cent at the end of September. That marks the slowest pace in decades, according to Gabriel Dechaine, an analyst at National Bank Financial. Strong commercial loan growth has been picking up the slack, but analysts are starting to wonder how long this particular engine can keep going.

“With the mortgage market slowing, it begs the question: How sustainable is the trend of double-digit commercial loan growth?” Mr. Dechaine said in a note.

Canada’s energy sector is also likely to emerge as a key theme. The price of Western Canadian Select crude, the heavy bitumen produced in the oil sands, has fallen 74 per cent since July, driving down energy stocks and raising concerns about the impact to the Canadian economy.

The last time oil fell sharply, between 2014 and 2016, bank stocks declined nearly 22 per cent over the same period amid concerns that struggling energy companies would have trouble meeting their debt obligations.

Perhaps bank stocks will perform better this time around. Valuations have fallen to 9.7-times estimated 2019 earnings – well below the 10-year average price-to-earnings ratio of 11.1, according to RBC Dominion Securities – which implies that bad news is already baked in.

As well, the Big Six emerged from the previous energy-fuelled downturn with their operations relatively unscathed, bolstering confidence that these financial behemoths can handle commodity turbulence.

“The banks still managed earnings growth of 6 per cent and 4 per cent in fiscal 2015 and fiscal 2016, respectively, and loan books would have benefited from clean up and monitoring brought on by the last downturn,” Mr. Sedran said.

But the lower oil goes, the bigger the worries.

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CIBC, RBC, Scotiabank Facing Fallout from Debt Restructuring in Barbados

The Globe and Mail, Tim Kiladze & James Bradshaw, 15 October 2018

A trio of Canadian banks is facing the fallout from a debt restructuring in Barbados that will slash the value of hundreds of millions of dollars worth of government paper they collectively own.

Canadian Imperial Bank of Commerce, Royal Bank of Canada and Bank of Nova Scotia are the largest lenders in the Caribbean, and each has direct exposure to Barbados. The country is home to one of the region’s largest economies, but the government’s finances have deteriorated over time. In May, a new prime minister, Mia Mottley, was elected and she has promised to make fiscal responsibility her top priority.

To help turn the economy around, the International Monetary Fund is working with Barbados to formulate a financial rescue plan. As part of this effort, the government proposed a debt restructuring in September that would amend the terms of its existing domestic debt. On Sunday, Ms. Mottley announced the restructuring plan will proceed.

Through the restructuring, Canadian banks will face losses on their debt holdings because Barbados has forced them to hold a greater percentage of their reserves in government debt, to help fund its deficits. These securities must now be held for much longer, and their coupons will also be cut, so the lenders will receive much lower returns on their money.

The total impact on Canadian lenders is still being calculated, but the three affected banks hold a substantial amount of Barbados debt. As of January, 20 per cent of their Barbadian reserves had to be held in government debt.

CIBC is the only bank of the three that has disclosed its exposure. In a regulatory filing earlier this year, the bank’s regional subsidiary, FirstCaribbean, which is based in Barbados, revealed that it had US$506-million worth of exposure to the government through securities and loans. Of that, US$445-million will be exchanged under the government’s plan, and the bank holds another US$30-million in debt instruments for which a restructuring plan has yet to be announced.

CIBC spokesperson Tom Wallis said the bank accepted the debt exchange offer, “remains fully committed to further negotiations” with the government of Barbados, and “will continue to exceed all of its regulatory and policy liquidity requirements.”

RBC and Scotiabank have not disclosed the extent of their exposure, but their regional headquarters are based in other countries: RBC in Trinidad and Scotiabank in Jamaica.

A spokesperson for RBC, Gillian McArdle, said the bank’s exposure to the distressed debt “is limited” and that RBC supported the government’s proposal. “Any potential impact from the government’s proposed debt exchange is not material to RBC,” Ms. McArdle wrote in an e-mail. “We are closely following developments in the country.”

A Scotiabank spokesperson declined to comment.

To help fix its finances, Barbados is relying on a common restructuring tactic, often referred to as “amend and extend.” As part of the Barbados Economic Recovery and Transformation (BERT) program, the government will amend the terms of its domestically held debt, and commercial banks will see their holdings broken into different tranches with maturities ranging from five to 15 years.

The coupons on this debt will also be significantly reduced. Before the restructuring, government treasury bills often paid interest rates around 3.5 per cent, and other government debt had interest rates as high as 7 per cent. Under the new terms, commercial banks will receive 1-per-cent coupons for the first three years; 2.5 per cent in year four; and 3.75 per cent annually until maturity.

On Sunday, the government said it received the support of 90 per cent of its debtholders eligible to vote on the restructuring proposal. “I’m happy to report that having received the support and the positive vote of all of our banks, our insurance companies ... we are now in a position to address their peculiar needs within the next few weeks,” Ms. Mottley said in a public address.

With this backing, the IMF is now likely to release the full US$290-million it has pledged in financial support, providing Barbados with crucial foreign reserves during the turnaround.

However, CIBC, RBC and Scotiabank are still wrestling with abnormally high risk in the region. At the end of fiscal 2017, Scotiabank reported $1.2-billion worth of gross impaired loans across the Caribbean and Central America – beating its total of $1.1-billion for all of Canada. In the same period, RBC reported a gross impaired loan ratio of 6.33 per cent in the Caribbean, many multiples higher than its 0.24-per-cent ratio in Canada.

The region’s woes have hit CIBC particularly hard. In 2014, 58 per cent of the bank’s total gross impaired loans came from the Caribbean, leading to a $420-million writedown on the division that year. In the most recent quarter, CIBC earmarked $44-million to cover expected losses on impaired FirstCaribbean loans, in large part because of Barbados’s financial woes.

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CIBC CEO Victor Dodig

The Globe and Mail, James Bradshaw, 28 September 2018

It’s client appreciation day at Canadian Imperial Bank of Commerce in Montreal, and chief executive Victor Dodig is in his element.

Stepping into a wood-panelled boardroom one morning in March, the energetic Mr. Dodig is slightly behind schedule, and he apologizes to two dozen private-wealth managers and investment advisers who’ve gathered to meet the boss. Before the day is done, he’ll also visit three bank branches and a call centre. Wealth management, in particular, is near and dear to him – he led the division before he was named CEO in 2014.

In shirtsleeves, having shed the jacket of his grey suit, Mr. Dodig leans against a counter set with pastries. Cradling a paper coffee cup, he paints a picture of an institution that is picking up steam. “I think our bank is on the right track,” he says, while acknowledging there are things that still need fixing. "When you look at where we’ve come from, from the financial crisis nine years ago, I’m not so sure that anybody would have predicted that we’d be where we are today.”

The bank Mr. Dodig inherited was still picking itself up from that crisis. CIBC was the only Canadian bank to suffer such huge writedowns on soured U.S. debt that it fell into the red, losing $2.1-billion in 2008. That solidified its reputation as Bay Street’s most error-prone bank, and management grew ever more insular, risk averse and focused on its fortress in Canada. Once one of the largest of the Big Six banks, it was mired in fifth place without a clear plan to regain its momentum.

“We were the bank that ran into sharp objects, we were the bank that had all kinds of losses, we were the bank that seemed to make a lot of mistakes,” he reminds his Montreal audience.

It’s been Mr. Dodig’s job to change that perception, and it’s still an uphill battle. When he emerged as a dark-horse candidate to win the top job in 2014, Bay Street greeted him as a breath of fresh air. With a leadership shuffle that moved more than 40 executives to new roles, plans under way to build new Toronto headquarters and other initiatives, he’s put his stamp on the bank and revitalized its culture.

Early in his tenure, however, Mr. Dodig sent mixed messages about the bank’s strategy to re-establish itself in the United States. He then pursued a drawn-out acquisition of Chicago-based PrivateBancorp Inc. last year for US$5-billion – an ambitious gambit at a price that alarmed investors and analysts.

CIBC is still No. 5, trailing its peers on important measures such as its efficiency ratio and five-year total shareholder return. After four years under Mr. Dodig’s watch, a crucial question remains: When will his strategy move the needle for CIBC’s weary shareholders?

At the morning gathering in Montreal, one of the wealth managers soon zeroes in on a sore spot: Why does the bank’s price-to-earnings multiple – which has hovered around 10 times trailing 12-month earnings this year – still lag behind the other Big Five banks? “It’s the thing I lose the most sleep over!” Mr. Dodig replies, his voice instantly rising. "It really bugs me.”

He rattles off a list of accomplishments: CIBC has grown year-over-year earnings a share for 14 straight fiscal quarters (the streak is now at 16), closed the PrivateBancorp deal and maintained a strong capital buffer, with room to make more acquisitions and weather a downturn. "And the market’s like, well, that’s not good enough,” he says. "I don’t know what is good enough.”

"One of the things that an investor told me, he said, 'Victor, the real problem is you want to forget your past, but your past doesn’t want to forget you,’ ” Mr. Dodig says. "And I said, 'Okay, when does that stop?’ ”

It’s easy to forget that CIBC was briefly the biggest bank in Canada in the late 1990s.

For a fleeting moment in 1998, it had greater assets than Royal Bank of Canada (RBC), and an aggressive plan to consolidate its advantage. Under then-CEO Al Flood, CIBC engineered a proposed merger with Toronto-Dominion Bank (TD) in which TD would have been very much the junior partner. But the federal government blocked the deal, as well as RBC’s attempted tie-up with Bank of Montreal (BMO).

Over the next decade, CIBC suffered through several bouts of turmoil. After failing to secure a merger, Mr. Flood gave way in 1999 to John Hunkin, a star investment banker who embarked on a series of ill-considered gambits that included the launch of Amicus, a U.S. electronic bank that CIBC shuttered after just two years because of heavy losses, and a push into Wall Street investment banking.

In the early 2000s, the capital markets division was CIBC’s centre of power, led by hard-driving David Kassie. Under Mr. Hunkin and Mr. Kassie, the bank amassed more than $5-billion in loans to telecommunications and cable companies. But when the sector imploded in 2001 and 2002, banks around the world suffered heavy loan losses. Among Canadian lenders, only TD had greater exposure to bad loans.

The excesses didn’t end there. CIBC soon became ensnared in the Enron accounting scandal – accused of helping executives move billions of dollars off the energy company’s balance sheet using elaborate financial engineering.

By 2004, CIBC had squandered enough capital that one analyst memorably described it as the bank "most likely to walk into a sharp object.”

The following year, Mr. Hunkin sailed into the sunset – somewhat literally – spending part of his last summer as CEO steering his 48-foot-yacht up the Atlantic coast. Stepping into his shoes was Gerry McCaughey, a detail-oriented financial engineer whom Bay Street considered withdrawn and eccentric.

Mr. McCaughey set about trying to change the bank’s personality, ushering in an era of retrenchment and aggressive “derisking.” On his first day on the job, the bank agreed to pay US$2.4-billion to settle a class-action lawsuit brought on behalf of Enron investors – eclipsing CIBC’s entire 2004 profit of $2.2-billion.

The year 2005 was also when CIBC hired Mr. Dodig to lead its wealth management arm. He’d spent the previous three years as CEO of UBS Global Asset Management Inc.’s Canadian outpost, and had experience in the United States and the United Kingdom with Merrill Lynch & Co. Inc.

Under Mr. McCaughey’s derisking mantra, CIBC largely retreated from the United States back to the safe harbour of Canadian retail banking. But that didn’t save it from being hit hard by the U.S. subprime mortgage crisis in 2007.

Once again, CIBC had to book massive writedowns – more than $9-billion over two years – delivering another shock to investors who took Mr. McCaughey at his word that he had made the bank safer.

“We were not so pleased with it and Gerry was not so pleased with it,” says Charles Sirois, a telecom executive and long-time CIBC director who served as chair from 2009 to 2015. "That was something [that fell through] the cracks.” Through the bank, Mr. McCaughey declined an interview.

By 2014, CIBC was back on firmer footing, but still highly risk-averse. Board members wanted to see renewed growth, and pushed Mr. McCaughey to announce his impending retirement.

The board had been quietly scouting for candidates inside and outside the bank for years, Mr. Sirois says. Even so, there was no clear succession plan.

The most obvious internal candidate was Richard Nesbitt, who was then the bank’s chief operating officer and had been CEO of the Toronto Stock Exchange. But he was a polarizing figure, a disciple of Mr. McCaughey and his roots were in the high-flying investment banking arm that had landed CIBC in hot water. With no path to the CEO’s office, Mr. Nesbitt left the bank in 2014.

“We were looking for somebody that would change the direction,” says John Manley, who joined CIBC’s board in 2005, and succeeded Mr. Sirois as chair in 2014.

Mr. Dodig was not a leading contender early on, according to sources familiar with the process, but he emerged as a strong one to change the bank’s course. While running wealth management, he had a front-row seat during a difficult decade.

At the time, the risk management department’s role "was really to say no,” says Laura Dottori-Attanasio, CIBC’s current chief risk officer.

The rigour was necessary, but demoralizing. In some ways, it was “like applying chemotherapy,” Mr. Dodig recalls. "The bad cells get killed, but the normal cells get damaged.”

After he was named CEO and took charge in September, 2014, the bank’s stance started changing. “We worked on building up a high degree of trust,” says Ms. Dottori-Attanasio, restoring "a balance between risk and return.”

Somewhere between a plate of veal Parmesan and a digestive glass of chamomile grappa, Mr. Dodig, 53, expounds on his philosophy for building a team of bankers: "No mercenaries, just missionaries,” he says.

We’re eating dinner at an unfussy Italian restaurant in west-end Toronto, not far from where Mr. Dodig grew up. For the evening, he’s traded in his suit and tie for khakis and an open-necked shirt, and brought his wife, Maureen, who nibbles at a salad before excusing herself to take the couple’s youngest son to a soccer match.

The eatery is a regular haunt, and one of many lasting connections he has to Toronto’s west side.

Over three hours and three courses, Mr. Dodig espouses a low-profile, workmanlike ideal for banking. Missionaries, he says, want to build long-term value for the bank and its clients. Mercenaries, by contrast, are only “in for the transaction.” In his estimation, short-term decisions affect only about 10 per cent of a bank’s earnings, which is why Mr. Dodig eschews "star bankers,” who "want to basically have their name encrusted in diamonds.”
The seeds of his philosophy were planted in childhood. Mr. Dodig’s late father, Veselko "Bill” Dodig, was a refugee from Croatia who settled in west-end Toronto with his wife, Janja, in the early 1960s. Bill worked in factories that made gaskets, industrial wire and cable, even chocolate, while Janja cleaned houses. The couple rented out three floors in Mr. Dodig’s childhood home on MacDonnell Avenue for extra income.

The family’s Croatian heritage is at the core of Mr. Dodig’s identity. He visits the country often, and owns a vacation property there that produces lavender and olive oil.

But he describes his upbringing in Toronto most vividly. He remembers visiting the Canadian National Exhibition in summer, though he wasn’t always allowed to spend money on rides.

Other times, he’d line up for the public swimming pool at Sunnyside Beach on Toronto’s lakeshore and wonder who belonged to the upscale Boulevard Club next door, where he’s now a member.

When he suffered from high fevers, he was treated at St. Joseph’s Health Centre, where he was born, and where he’s now co-chair of a fundraising campaign that has raised $90-million.

After high school, Mr. Dodig studied commerce at the University of Toronto, and had a part-time job as a teller at a suburban CIBC branch, starting in 1985. Two years later, he interned at accounting firm Arthur Andersen, where a partner encouraged him to pursue an MBA at Harvard Business School. He did, and graduated in the top 5 per cent of his class in 1994. He also met Maureen while in Boston: The couple got engaged after eight months, married six months later and now have four children.

Friends and colleagues praise Mr. Dodig’s consistency of character. At work and in private, he’s animated and funny, with an encyclopedic memory for names, faces and personal details. He also has a formidable intellect and a deep curiosity about many subjects, including politics, technology and sport.

From time to time, he reveals an endearing, youthful streak. For a while, he was transfixed by HQ, an online trivia game, though he’s fallen out of the habit of playing daily. He’s also a self-described "Disney aficionado,” visiting its theme parks regularly. He spent part of March break with Maureen and two of their children in Florida, braving lineups to ride Space Mountain. He posted a family photo wearing Mickey Mouse ears on his blog, praising the park’s "client first attitude.”

CIBC’s client appreciation days, held at least three times yearly, play to Mr. Dodig’s people skills and preoccupation with the bank’s culture. Over two days in Montreal in March, he meets with investors, dines with small business clients and quizzes staff at every turn.

At a CIBC call centre, he strides through rows of cubicles, asking employees about their jobs and families. He also gently probes for problems: "What can we do better?” and "Any advice for me? C’monnn…”

At every turn, he snaps selfies, some of which appear on the bank’s internal blog. "What a good-looking group, excellent,” he says after one shot, then exclaims to a colleague with a similarly balding pate: "No shine off our two heads!”

If Mr. Dodig has an Achilles heel, it’s operations – the nuts-and-bolts processes that make banking work. Over his career, he’s rarely held intense operational roles with large staffs or the most complex moving parts.

His affinity for making connections is also strategic. Investments, deposit accounts and mortgages are commodities that can be copied by rivals, he says. "The only way you can differentiate yourself is by the relationships we can build with our clients.”

Any bank will say it puts clients first, and all CEOs meet with stakeholders. But Mr. Dodig devotes more effort to it than most. In his first year as CEO, Mr. Dodig met one-on-one with 165 CEOs and business owners, hosted 22,000 clients at 145 events and met more than half of the bank’s institutional investors.

He has also begun forging closer ties to the technology sector. Earlier this year, the bank acquired specialty-finance firm Wellington Financial LP for an undisclosed sum and made it the core of a new niche unit dubbed CIBC Innovation Banking, launched to finance early- and mid-stage technology firms.

But CIBC faces an uphill battle in trying to snatch business from sector rivals such as Silicon Valley Bank Inc. and Comerica Inc. And CIBC will have to be creative to keep pace with rival Canadian banks in upgrading its own technology. RBC and Scotiabank are each spending more than $3-billion annually – largesse that CIBC simply can’t match.

Still, the Wellington deal has helped revive a halo of innovation around CIBC, which has a history of being early to new technologies, such as ATMs and telephone banking.

John Ruffolo, adviser to OMERS Ventures, has known Mr. Dodig since they were summer students at Arthur Andersen in the late 1980s, and says his firm has moved business to CIBC. "They are all over us and all over our investments in trying to service them very aggressively,” Mr. Ruffolo says.

Mr. Dodig’s tireless bridge-building with clients made him a darling of Bay Street early in his tenure. But the honeymoon ended when he elected to spend top dollar to establish beachhead in the hyper-competitive U.S. banking market.

Chicago’s financial core is a monument to banking’s power and influence. To stroll through it is to wonder that there was enough stone, marble and steel left over to build the rest of the city.

The headquarters of the former PrivateBancorp on LaSalle Street, now adorned with CIBC logos after being renamed CIBC Bank USA, is no exception. Its opulent main level is ringed with marble columns reaching to an ornate ceiling, where commercial bankers sit at rows of dark-wood desks.

From here, Mr. Dodig intends to build out a U.S. bank that can work seamlessly across the U.S.-Canadian border. But directly across the street is a steel-beamed tower that houses the U.S. headquarters of BMO, which has been firmly established in the Midwest since 1984. CIBC has a lot of catching up to do.

With a backpack slung over his shoulder, Mr. Dodig arrives with Larry Richman, who was CEO of PrivateBancorp and has stayed on with his executive team since last year’s acquisition.

The two men sit on opposite sides of a table in a small boardroom adorned with Chicago sports memorabilia, including a football signed by legendary Bears running back Walter Payton. Mr. Richman, 66, is polished, with the swept-back hair and bright smile of a man whose handshake has sealed countless deals.

Mr. Richman says he and Mr. Dodig hit it off from the start of CIBC’s courtship: "If you don’t like each other, or if you don’t have the respect and the culture, life’s too short.”

But their alliance didn’t come easily, nor was it cheap.

PrivateBancorp wasn’t Mr. Dodig’s initial target. Early on, he had clearly telegraphed that he was hunting for a U.S. wealth manager, expecting to pay between US$1-billion and US$2-billion. But prices soon climbed too high for wealth management firms, which wouldn’t add deposits – a priority for CIBC. At a 2015 investor day, Mr. Dodig upped his price range to as much as US$4-billion.

Two months later, CIBC dumped the 41-per-cent stake in wealth manager American Century Investment Management Inc. that it acquired in 2011. When leading CIBC’s wealth-management unit, Mr. Dodig had nurtured American Century, but as CEO he saw no clear path to own the firm, and sold it for US$1-billion.

Even so, Bay Street was caught off guard in June, 2016, when CIBC offered US$3.8-billion for PrivateBancorp, which is primarily a commercial lender. The abrupt shift in direction confused investors and analysts.

At US$47 a share, the offer was 24-per-cent higher than PrivateBancorp’s average share price over the prior 10 days. Already there were concerns CIBC was overpaying, and those voices grew louder.

And then Donald Trump was elected President.

By late 2016, U.S. stock markets were soaring, fuelled by expectations of tax cuts and regulatory reform after Mr. Trump’s surprise win. By early December, the KBW Regional Bank index, a benchmark for PrivateBancorp shares, had risen by 44 per cent since the deal with CIBC was announced in June. CIBC’s offer suddenly looked cheap.

In the week before a scheduled Dec. 8 vote by PrivateBancorp shareholders, two influential proxy advisory firms, Institutional Shareholder Services Inc. and Glass Lewis & Co., recommended that they reject CIBC’s offer. PrivateBancorp had to postpone the vote, and CIBC set a new summer deadline. In the meantime, Mr. Dodig hoped U.S. bank valuations would come back down to earth.

They didn’t, but he was determined not to let the deal slip away.

PrivateBancorp rescheduled the vote for May, CIBC sweetened its bid in March, then tabled its "best and final offer” a week before shareholders met: US$60.43 a share. That won shareholders over, but the US$5.0-billion price tag made it one of the largest post-crisis acquisitions of an American bank.

Analysts and investors harboured serious concerns that CIBC had overpaid for a mid-market commercial bank that offered no real cost savings because it had little overlap with CIBC’s existing business.

“There’s still upside and we’re seeing that in the results. But the upside was nowhere near as significant as it would have been,” says John Aiken, an analyst at Barclays Capital Canada Inc. “They were a month away from timing it brilliantly.”

The Chicago-based bank’s rising profits since the acquisition – boosted by U.S. tax reform and interest-rate hikes – have quieted many doubters, at least for now.

"The valuation they paid was looking a bit expensive at the time, but I was wrong,” says Steve Belisle, senior portfolio manager for Canadian equities at Manulife Asset Management Ltd., which owns a large block of CIBC shares. "If you look at the [U.S. bank] transactions that happened after that, I don’t think it was unreasonable.”

But CIBC faced another nagging question: Had it landed the prize it truly wanted, or simply the best bank available in an expensive market?

“[It wasn’t] about, let's go find something to buy,” Mr. Dodig says. CIBC had a large base of Canadian commercial customers that do business in the United States. To them, he says, “we were the one-armed bank.” Rivals TD and BMO both had large U.S. networks.

Mr. Dodig is encouraged by CIBC Bank USA’s results so far. For the quarter ending July 31, the division chipped in $121-million, and U.S. operations accounted for nearly 16 per cent of CIBC’s total profit. "I think we’re on track and we’re ahead of track,” he says.

But Mr. Dodig has also moved the goalposts. The day the deal was announced, he set an “audacious” goal that U.S. operations would contribute 25 per cent of CIBC’s earnings in five to seven years. Analysts worried that meeting such a tight timeline would require another large acquisition too soon, and Mr. Dodig had to calm their nerves. He now cites a “five- to 10-year” horizon.

“It’s doing more with our existing clients. It’s growing new clients,” Mr. Richman says. “Plus, it’s such a big market. You can grow significantly and you don’t have to win every deal.”

For all the progress CIBC has made under Mr. Dodig, the bank has yet to close the valuation gap to its peers. That suggests that some investors still fear the next sharp object could be just around the corner.

One of the biggest worries is CIBC’s exposure to Canadian real estate. Residential mortgages and home-equity loans still make up about three fifths of CIBC’s loan book, compared with an industry average of 46 per cent. That’s a red flag for many investors, including U.S. short sellers who are bearish on Canada’s housing markets.

Since 2012, CIBC has wound down its FirstLine Mortgage business, which sold mortgages through outside brokers. In its place, the bank built a roster of in-house mobile mortgage advisers, and tasked them with adding mortgages at a rapid rate. As recently as last year, CIBC’s mortgage book was growing by 12 to 13 per cent annually, double the rate at the other Big Six banks.

“The real question is, if we end up in a situation where housing sales are flat to down, and the mortgage growth goes with it, is CIBC still going to be able to grow earnings in their Canadian business?” says Sumit Malhotra, an analyst at Scotia Capital Inc. "They’re clearly the most exposed from a lending perspective.”

Mr. Dodig sees mortgages as a tool to acquire new clients, then sell them other products to cement the bond. About 85 per cent of clients who had a mortgage with CIBC through the old broker business had no other link to the bank. By contrast, three quarters of newer mortgage clients acquired in-house have at least one other CIBC product, and 55 per cent have a deposit or investment account.

When investors fret about the bank’s mortgage exposure, Mr. Dodig tells them: "It’s a good exposure. Get enamoured with the fact that we can actually grow those relationships over time.”

This year, CIBC has hit the brakes on its mortgage growth amid tightening federal regulations on borrowers, and is trying to diversify its Canadian lending. Mr. Dodig is keen to expand the bank’s commercial lending – he often talks about "putting the commerce back in CIBC.”

The bank is also pushing to grab back market share in credit cards, where it was once a clear front-runner. It had a monopoly on the Aerogold Visa card tied to Air Canada’s Aeroplan loyalty program until 2013.

But the U.S. expansion plan is another question mark. To reach CIBC’s U.S. profit goals, Mr. Dodig will eventually need to make further deals. Analysts and investors are nervous about how CIBC allocates capital, given the mixed messages the bank has sent in the past and the hefty price PrivateBancorp commanded.

“Hopefully they don’t do any other big deals,” says Mr. Belisle of Manulife. "That’s another concern that’s impacting the stock: People assume they will blow their brains out and do another one.”

Mr. Dodig has tried to assuage those fears, repeatedly saying he would consider a smaller deal for $400-million or less, but that larger deals are off the table for now.

He also prefers not to judge CIBC’s progress by its size. “If I look at some of the best financial institutions in the world, they're not the biggest, they're highest performing on a number of different metrics.”

Those yardsticks include return on equity, efficiency and total shareholder return. On each, CIBC has made strides under Mr. Dodig and he’s brought the bank out of its shell. But it still needs to do more to outrun its past and can ill afford many setbacks.

All Mr. Dodig asks is for a little patience. “As [we] transform our bank, it’s a journey, right?” he says. "It’s not like it’s a straight line up.”

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Manulife Offers to Pay People to Leave IncomePlus

The Globe and Mail, Rob Carrick, 21 September 2018

If you’re part of the crowd who put money in Manulife Financial Corp.’s IncomePlus guaranteed retirement income product after it debuted in 2006, watch your mail for a surprising offer.

You can continue to hold IncomePlus, or move without penalties into the company’s GIF Series 75 segregated (seg) funds with some money thrown in as a sweetener by Manulife. Yes, a major financial company is offering a bonus to get clients out of one of its products.

The knock on IncomePlus has always been unusually high fees and a lack of flexibility. But there’s no question that its core mandate speaks to a primal need that some people have for assurances that their retirement savings won’t run out. In its heyday, IncomePlus guaranteed that you could withdraw 5 per cent of your investment annually for life starting at the age of 65.

IncomePlus was designed for people who put a high value on guaranteed income, but also have conventional retirement savings that could be used to cover large, unexpected expenses. Rona Birenbaum, a financial planner with Caring For Clients, said IncomePlus is still appropriate for this type of investor. “If the product was sold properly in the first place, it should only be sold now if the client’s situation has changed.”

In 20 years of covering personal finance, I have rarely seen a buzz over a new investing product like there was with IncomePlus. Deposits surged past $6-billion within two years, and other insurers quickly introduced similar products of their own.

Then came the global financial crisis and its aftermath. Manulife found itself having to commit significant funds to backstop guarantees that clients would never run out of income. Subsequent versions of IncomePlus became less attractive, and clients began pulling money out of the product.

“We know that some of our customers feel the product doesn’t meet their needs any more,” said Marie Gauthier, associate vice-president of segregated funds at Manulife Financial.

Manulife stopped offering IncomePlus in 2013. Now, it's trying to entice clients who bought the early version of the product, sold between 2006 and 2009, to head for the exit. The company says this version accounts for about half of current IncomePlus assets.

Manulife began mailing letters to eligible clients this week, which means they should start arriving any day now. If you get one of these letters, be sure you understand the difference between IncomePlus and GIF Select 75. Both involve investments in segregated funds, which are a type of mutual fund offering a degree of principal protection and estate planning features. IncomePlus adds the guaranteed income for life feature, at an extra cost.

Something to consider if you get the letter is whether you have additional retirement savings to draw from. This may not be the case because in the initial excitement over IncomePlus, both clients and advisers got carried away with its promise of guaranteed income. “I know from stuff we’ve seen that a lot of times, everything [the client] had was put into this vehicle,” said Daryl Diamond, a Winnipeg-based certified financial planner (CFP) and author of Your Retirement Income Blueprint.
IncomePlus can work well to generate reliable income at the promised rate. But you can negatively affect your guarantees if you withdraw a block of your original investment or increase the amount of income you draw.

High fees are another issue with IncomePlus. There are two fees to understand – those charged by the seg funds used in IncomePlus and the fee associated with the guarantees of the product, which ranged from 0.55 per cent to 1.25 per cent. An example provided by Manulife uses a global neutral balanced fund with a management-expense ratio of 2.91 per cent and an IncomePlus fee of 1.25 per cent, for an astronomically high total of 4.16 per cent.

“Some [clients] are still happy with the guarantees in IncomePlus, but some of them find the fees are too high,” Manulife’s Ms. Gauthier said.

Here’s some context that shows just how high those fees are: Guidelines produced for Canadian financial planners suggest using 4.48 per cent as a gross return in projecting long-term investing results for conservative clients.

The money Manulife is offering clients who switch out of IncomePlus can be considered compensation for those hefty guarantee fees paid in the past. The payments are calculated according to factors such as the market value of the client’s IncomePlus holding, the guaranteed payment amount, and the client’s age. Expect payments to average 13 per cent to 15 per cent of the market value of an IncomePlus contract. The payments are taxable when deposited into non-registered accounts.

Clients are encouraged to discuss the change with the selling adviser, who will in most cases receive a $500 payment from Manulife as compensation for the work involved.

The fees charged on IncomePlus look particularly high in light of the fact that the product doesn’t allow you to stretch for higher returns by using all equity funds. This option is open to you if you accept Manulife’s offer to move out of IncomePlus and into its GIF Select 75 series of seg funds.

These funds are comparatively expensive in today’s fund universe, as seg funds tend to be, but they have some advantages. Notably, seg fund holdings can be passed to a named beneficiary after you die without probate fees.

There are two notable takeaways when you switch to GIF Select 75 from IncomePlus. The first is a reset feature whereby the pool of money you have available to withdraw from in retirement is adjusted higher every three years to reflect increases in the market value of your account.

The second takeaway is the loss of a 5-per-cent bonus paid every year an IncomePlus client doesn’t make a withdrawal. These bonuses add to the amount used to calculate your guaranteed withdrawals.

Ms. Birenbaum described the terms of the original version of IncomePlus as “generous.” But the product has a flaw as a retirement income tool – those guaranteed 5-per-cent payments assume you won’t need to dig into your principal. “The majority of Canadians in my view are going to spend down their capital,” she said. “Also, that 5 per cent [annual income] is not inflation indexed.”

Mr. Diamond said the appropriate use of IncomePlus would be to combine it with the Canada Pension Plan, Old Age Security and any personal pension benefits to cover what he calls “hell-or-high-water expenses” – heating, property taxes and so on. He suggests having other investments to add flexibility to your retirement income so you can make a large withdrawal if required.

All investors, whether they bought IncomePlus or not, should remember it for the lesson it teaches about not buying hot new investment products on hype. “As many of these new things are, IncomePlus was oversold, missold and not properly understood by advisers and investors,” Ms. Birenbaum said. “And I even think Manulife didn’t quite know what it was creating.”

Q&A: Manulife’s offer to IncomePlus clients

What’s the deal?

Switch out of IncomePlus into Manulife’s GIF Select 75 segregated (seg) funds and receive a bonus to be deposited in your seg fund account.

What is IncomePlus?

The technical term is guaranteed minimum withdrawal benefit. In exchange for investing a lump sum with Manulife, you get a guaranteed flow of income in retirement.

Who is eligible for the offer?

Owners of the original series of IncomePlus, sold in the mid to late 2000s. Different versions of IncomePlus were offered in later years.

How and when will I hear about the offer?

Manulife began mailing out notifications to eligible IncomePlus customers starting in mid-September.

How much might the bonus be worth?

An average 13 per cent to 15 per cent of the market value of your IncomePlus account.

Why is Manulife making this offer?

IncomePlus has become increasingly expensive to offer in a cost-effective way. The bonus is a way of compensating clients for fees they paid to have their retirement income guaranteed through IncomePlus.

If I’m happy with IncomePlus, can I pass on the offer?

Yes, it’s up to clients.

Can I do a partial transfer and get the bonus?

No, only full transfers are eligible.

What about tax?

There are no tax consequences if you move from IncomePlus to GIF Select 75 while keeping your money in the same segregated funds; moving into different funds in a non-registered account would be a taxable disposition. The bonus amount is taxable in a non-registered account.

What is the deadline for deciding?

Manulife must receive documentation that you want to switch by Friday, Dec. 14. If you do nothing, you will remain in IncomePlus. You can still switch out of IncomePlus after the deadline, but without a bonus.

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Aggressive Acquisition Strategy Hits Scotiabank’s Stock Price as Investor Skepticism Mounts

The Globe and Mail, Tim Kiladze, 12 September 2018

After a stunning run of acquisitions, Bank of Nova Scotia is feeling the heat. Shares of Canada’s third-largest lender are suffering relative to rival Big Six banks, and the pressure is on management to prove its recent spate of deals was worth it.

In the past 10 months, Scotiabank has spent nearly $7-billion on acquisitions, including $2.6-billion on its purchase of asset manager MD Financial in May and nearly $1-billion for storied money manager Jarislowsky Fraser in February.

As Scotiabank acquired, its stock has struggled. Over the past year, shares of Canada’s Big Six banks have delivered an average return of 14 per cent, while Scotiabank’s stock is down 2.7 per cent.

This underperformance can be traced back to multiple issues. North American free-trade agreement negotiations weigh on Scotiabank more than its rivals because it has a large Mexican operation. Investors' recent fears about emerging markets also hurt the lender more than usual, because it is Canada’s most international bank – with a particular focus beyond Canada’s borders on what it calls the Pacific Alliance countries: Mexico, Colombia, Peru and Chile.

However, against this macroeconomic backdrop, Scotiabank decided to go buying, and that strategy “has triggered a variety of investor concerns,” National Bank Financial analyst Gabriel Dechaine wrote in a research report.

“Successful integration (i.e. execution) of recent acquisitions is arguably the most important driver of Scotiabank’s long-term upside potential,” he added.

Scotiabank could not be reached for comment, but chief executive Brian Porter has acknowledged in the past that buying is always the easy part. Making deals profitable, especially after paying hefty takeover premiums, is much harder work.

Canada’s banks have been big buyers in the wake of the 2008 financial crisis, spending a collective $40-billion on deals since, according to National Bank Financial. During this run, Scotiabank has been the most acquisitive lender, shelling out $13-billion, or 30 per cent of the sector’s total – and close to double the second-most active buyer, Royal Bank of Canada.

Scotiabank’s notable deals during this time frame include the purchases of DundeeWealth and ING Bank Canada, inked by former CEO Rick Waugh in 2011 and 2012, respectively. Mr. Porter spent the first few years of his tenure, which started in 2013, focused on cutting costs and reducing overlap in the bank’s international arm after a string of acquisitions overseas by Mr. Waugh. “I knew when I got this position, the first thing we had to do was something in the international bank, given that we’d been very acquisitive,” he told The Globe and Mail in 2016.

But now Mr. Porter must integrate his own deals, and investors seem skeptical of success. Using a price-earnings ratio, Scotiabank’s shares are now valued at their lowest level relative to its peers since the height of the recent oil and gas crash in 2016, which hurt the bank more than most rivals because it has a large energy-lending business in the United States. It hasn’t helped that Scotiabank issued a large amount of equity to help pay for one of the recent deals.

Despite the recent pressure, Scotiabank has argued in the past these deals will pay off in the long-run, and there is some acknowledgment they could pay enormous dividends.

In an August research note, CIBC World Markets analyst Rob Sedran noted the recent deals will increase Scotiabank’s scale and improved its market positioning in the Pacific Alliance, thanks to the acquisition of BBVA Chile, and its recent wealth-management deals at home will help the bank target richer clients, who offer the most profit margin.

“There is lots of work to be done and the easy part (cutting the cheque) is now in the past. To the extent the bank can execute as it has in the past, we think its strategic positioning has been advanced,” Mr. Sedran wrote.

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CIBC’s Victor Dodig Warns About Global Debt Levels; Urges Canada to Prepare

The Globe and Mail, James Bradshaw, 11 September 2018

The chief executive officer of Canadian Imperial Bank of Commerce is sounding an alarm over rising global debt levels, warning that Canada needs to start preparing now for the next economic shock.

After a decade of “tremendous growth” in debt markets fuelled by ultra low interest rates, “cracks are starting to appear in certain areas,” according to CIBC CEO Victor Dodig, who issued a call to action on issues ranging from foreign direct investment to immigration in a speech to the Empire Club in Toronto on Tuesday.

Low interest rates introduced to speed the recovery from the last global financial crisis have remained low, and Mr. Dodig thinks economic historians will ultimately decide they were “too low for way too long.” As those rates rise, emerging economies in Turkey, Argentina and Indonesia are struggling with weakened currencies, making it increasingly difficult to pay back their foreign debts. And even as economic conditions in Canada remain strong, giving Mr. Dodig reason to be optimistic, he worries that developing problems could ripple through interwoven financial markets around the world.

“It sounds counterintuitive, but that same debt that helped the world recover is actually infusing risk into the global financial system today," Mr. Dodig said. “I think there’s a real serious global challenge of this low-interest-rate party developing a big hangover."

Sitting at the helm of Canada’s fifth-largest bank, which has more than $377-billion in loans outstanding and an expanding U.S. banking division, Mr. Dodig frets over the outcome. He used his speech to propose some remedies that he believes would make Canada’s economy more resilient in the face of a downturn.

The first is to clarify rules around foreign direct investment, which is falling in Canada. The main culprit, he argues, is the uncertainty plaguing large business deals that require approval from Ottawa under opaque foreign-investment rules – and he cites the turmoil surrounding the Trans Mountain pipeline expansion as an example. Foreign investors “need confidence. They need an element of certainty. They need to know the rules. They need a clear understanding of how things get approved," Mr. Dodig said. “We need our approval systems to work better, and to work more predictably, because they have other choices.”

Mr. Dodig also called for more immigration to Canada, asking the government – which has already set higher immigration targets for the coming years – to open its arms even wider. In particular, he highlighted pilot projects such as the Global Talent Stream, which helps speed the process when companies hire highly skilled workers from abroad, as worthy of being made permanent.

“I think we need to increase the number of people that we welcome to our country," he said. “We need to lean in at this moment in time. This is not a policy that can wait.”

And he called on governments and employers to work more closely with universities and colleges to match the skills graduates have to employers' needs, promoting what are known as the STEM disciplines – science, technology, engineering and math – as well as skilled trades. “There’s a gap today. We know there’s a gap," he said. “There’s a war for talent going on out there.”

Mr. Dodig also took aim at inter-provincial trade barriers he hopes to see removed, and which he called “an embarrassment to our country." And he urged the federal government to allow companies to expense capital investments within one year to be more competitive with U.S. rules.

Mr. Dodig acknowledged that some of the most acute threats to the global economy are beyond this country’s control, but cautioned Canadians not to get too comfortable while times are good. “We need to use this sunny time to enjoy our success, but to prepare for the future,” he said.

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Banks Have An Obsession with Cutting Costs Amid Record Profits

The Globe and Mail, Tim Kiladze, 9 September 2018

The extended bull market and booming economy is the stuff investors used to dream of. But for some, it's just not enough.

Coming off a quarter in which they collectively earned an eye-watering $11.6-billion, Canada's largest banks participated in a Bay Street conference last week where the main focus was, of all things, cost control.

It has been this way for a few years now. Whenever banks report earnings, or their leaders appear at investment conferences, they are grilled about expenses. What started as an obsession with restructuring charges, when the banks were booking ones worth hundreds of millions of dollars around 2014, has morphed into a fixation on so-called "operating leverage."

The term is a fancy one for measuring costs. If a bank has "positive operating leverage," its revenues are growing faster than expenses. “The operating leverage focus … has become a big part of the quarterly process,” Bank of Nova Scotia analyst Sumit Malhotra said at the conference, which was hosted by his employer.

Canada’s banks are riding a bull run for the ages. Since the start of 2010, the sector has delivered investors a total return – that is, one including dividends – of 157 per cent. Canadian energy companies have delivered just 7 per cent over the same time frame.
That impressive return is built on strong earnings growth. The economy has been improving for most of that eight-year period, save for an oil shock that rattled Western Canada starting in 2014. Loan growth has been good and credit losses low. Strong equity markets are also good for fees in the banks' large wealth-management businesses. And yes, part of the healthy profit picture is also a result of cost-cutting.

In 2014, four of the Big Six – Scotiabank, Royal Bank of Canada, Toronto-Dominion Bank and Canadian Imperial Bank of Commerce – had just named new leaders. There is a tendency for new chief executives to restructure, to trim the fat that builds up under their predecessors.

But the slashing continued from there, with the banks justifying their cost-cutting by warning of coming threats. The lending wave spurred by record low interest rates was waning, and tech giants such as Alphabet Inc.'s Google and Amazon.com Inc. are starting to wade into financial services. Because the banks have a lot of legacy staff, such as branch tellers, and because their back offices were horribly outdated after years of under investment, restructuring was necessary. Those efforts have trained analysts and investors to study the expense lines.

Cost control, of course, is important. With tens of thousands of employees each, the Big Six lenders can grow bloated. Nothing kills creativity like bureaucracy. But the banks have already racked up $2.6-billion in restructuring charges combined over the last five years. This May, Bank of Montreal announced its fourth restructuring charge in as many years – this time for $260-million. How much is enough?

Some senior bankers are starting to push back. Asked about Royal Bank of Canada's operating leverage at the conference, CEO Dave McKay argued this is not the time to be worried about expenses. For one, there's a shortage of expensive talent in areas such as artificial intelligence that must be hired to prepare for the next technological wave and build what he called the "bank of the future."

"I'd rather build it now with these tailwinds than when you don't have the interest rate tailwind, you don't have the credit risk tailwind, you don't have a strong economy," Mr. McKay said. "So I'm resisting the pressure from the sell side [analysts and investors] to say, 'Hey, what about last month's operating leverage?' "

Another important point: Banking is very much a people business, a fact that is sometimes lost in all the examination of expenses.

National Bank of Canada CEO Louis Vachon, when asked if he'd consider another restructuring charge, said: "You have to remember: These charges, some of them involve firing people, [and that] has a social and human cost to it." Refreshing, and true.

Take it from Tim Hockey, TD's former head of personal and commercial banking and now CEO of TD Ameritrade Holding Corp., who helped build one of the most respected retail banking franchises in North America. "In 10 years of meetings with analysts and stockholders at TD ... I would talk about the importance of what I used to call a 'caring performance culture,' and eyes would glaze over," he told me last year. But he swore by this focus. "Large organizations tend to drive the humanity out. When you're talking about workplaces of more than 1,000 employees, it's the soft stuff" that matters most.

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