09 September 2018

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.
;