25 December 2018

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.”

11 December 2018

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.


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.


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.


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.


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.


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.

09 December 2018

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.

04 December 2018

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.”