21 November 2019

TD CEO Bharat Masrani Knows When to Hold, or Fold, When the Stakes Are High

The Globe and Mail, Andrew Willis, 21 November 2019

Toronto-Dominion Bank chief executive Bharat Masrani, is one of those card sharks, caught in the late stages of a high-stakes game with Charles Schwab.

Do you ever watch poker tournaments on TV? Here’s what happens: The longer the game, the bigger the wagers get and the more likely players are to go bust when betting on a hand

Toronto-Dominion Bank chief executive Bharat Masrani is one of those card sharks, caught in the late stages of a high-stakes game in the U.S. discount brokerage industry. By all accounts, Mr. Masrani is about to do the sensible and boring thing, and walk away. It’s in keeping with an approach that colleagues say drives all the TD boss’s strategic decisions: Don’t do anything that could blow up the bank.

TD owns 43 per cent of TD Ameritrade Holding Corp. and is expected to support a widely reported but unconfirmed sale of the Omaha-based brokerage to industry leader Charles Schwab Corp. for US$26-billion in stock. Analysts project TD Bank will emerge from the transaction with a 10-per-cent to 15-per-cent stake in a merged company that dominates the do-it-yourself financial-services space.

Cutting a deal with Schwab would be a dramatic exit. Until now, Mr. Masrani backed increasingly large bets by the U.S. investment dealer. TD Ameritrade grew by making a series of acquisitions, each larger than the last. The most recent takeover, in 2016, saw TD Bank put up US$1.3-billion and TD Ameritrade throw in an additional US$2.7-billion to acquire rival Scottrade.

Another round of consolidation became all but inevitable in October, when Schwab decided to exploit its scale with a brilliant marketing move: It offered to let customers trade stocks for free. (Prior to that, Schwab charged US$4.95 per trade.) Schwab has approximately 12 million customers and more than US$3-trillion of assets under management.

Smaller rivals, including TD Ameritrade with about 11 million clients and US$1-trillion in assets, had no choice but to follow suit. The fee cuts will trim future profits, and TD Ameritrade lost a quarter of its market capitalization on the day Schwab changed the rules.

TD Ameritrade was widely expected to stage yet another takeover to keep pace with Schwab. “TD cannot stand still. This is a business of scale and they either have to get bigger or get out,” said Doug Steiner, former CEO of E*Trade Canada, which Bank of Nova Scotia acquired from E*Trade’s U.S. parent back in 2008 for $444-million.

TD Ameritrade’s logical target was New York-based E*Trade Financial Corp. But the table stakes have more than doubled since the Scottrade takeover. Acquiring E*Trade would cost at least US$10-billion. After putting that massive stack of chips into the game, Mr. Masrani would still own a large stake in a volatile brokerage business that is chasing the industry leader, and is not linked to TD’s core retail banking franchise.

TD’s other options included dropping US$12-billion to acquire 100 per cent of TD Ameritrade. Analyst Darko Mihelic ran the numbers in early October and said while the deal made strategic sense, there was no indication an offer was in the works. But Mr. Mihelic said the market expected a resolution on TD’s plans and "since this would be a large transaction with significant stock issuance, we believe many potential TD investors may stay on the sidelines for the foreseeable future.”

TD’s stock significantly under-performed Canadian peers in recent months, owing to uncertainty over the future of TD Ameritrade, according to analysts.

A deal with Schwab, if it happens, would make it easier for TD to expand in the United States, where it already has 1,250 branches. “Assuming a smaller stake in a bigger player situation, TD could have a more liquid asset that it could potentially sell to finance a future U.S. regional bank acquisition,” said Gabriel Dechaine, an analyst at National Bank Financial. In a report on Thursday, he said: “This scenario would be positive for TD’s long-term U.S. strategy.”

Over a 32-year-career at TD, including a four-year stint as chief risk officer, Mr. Masrani has seen the damage that can be done to a bank’s balance sheet when loans go bad, or a division stumbles. Long before former U.S. president Barack Obama made the phrase popular, TD’s boss lived by the motto “Don’t do stupid stuff.” Doing a deal with Schwab, rather than doubling down again on U.S. discount brokerages, is a winning bet.

15 November 2019

After A Rough Patch, Gerry Schwartz Bets On A New Approach at Onex

The Globe and Mail, Andrew Willis, 15 November 2019

Call it Onex 2.0.

Canada’s pioneering private-equity investor, Gerry Schwartz, is reinventing his firm on the fly. At a time when many of his billionaire peers are responding to increasing competition for deals – and their looming mortality – by closing down their funds to play with their grandkids, Onex Corp.’s 77-year-old founder and chief executive is in change mode at the $8-billion Toronto company.

Onex is shifting from selling primarily one product – leveraged buyouts – to a single group of customers – institutional investors – into a broader asset manager to try to win a following among wealthy, individual clients. Contemporaries such as Blackstone Group and Brookfield Asset Management are opening their doors to the same potential investors.

Mr. Schwartz is still staging bold takeovers, as witnessed by Onex’s unexpected $3.5-billion bid this spring for WestJet Airlines Ltd., two decades after the firm tried, and failed, to buy Air Canada. But the key to Onex’s future lies in a growth strategy that is partly based on fixing a struggling business, recently acquired money manager Gluskin Sheff + Associates Inc., and using its ties to affluent families to dramatically increase Onex’s size and profitability.

Mr. Schwartz, always introspective, and his senior colleagues also spent time this fall engaged in a productive session of corporate navel-gazing. The team stepped back and distilled the skills that helped Onex churn out an impressive 27-per-cent average annual return on investments over its 35-year history into a handful of lessons – call it the Gospel of Gerry.

The team also restructured the firm this fall, streamlining management and giving employees clear responsibility for specific investments in an effort to ensure accountability. These evolutionary steps are playing out at a time when Onex shares are underperforming the market. The company is struggling with a handful of problem children – a discount grocery chain and marine-survival equipment business – in its US$38-billion portfolio.

The reinvention of Onex started in June, when the firm closed its purchase of Gluskin Sheff for $445-million. The acquisition added plain-vanilla wealth management, in the form of funds that invest in stocks and bonds, to Onex’s more exotic investment offerings, which include funds that buy entire businesses and invest in loans and other credit products.

After quietly sewing the two businesses together over the past five months, Mr. Schwartz opened up about how everything is fitting together last week before an audience of 850 finance types at the Toronto CFA Society’s annual dinner. He started by highlighting the obvious, explaining Onex is always looking for new customers and it bought a platform that serves some of the wealthiest individuals in Canada. ”We think Gluskin Sheff represents a huge opportunity,” he said.

Then he dived into the strategy. Rather than competing based on low fees or last year’s performance numbers, he said, it’s all about trying to provide white-glove service to the rich. And that means more than investment products. ”Gluskin Sheff has the ability to be close to clients, to talk to them not just about their investment returns, but about their interests in philanthropy, then introduce them to charitable opportunities and build a vibrant, strong relationship.”

Gluskin Sheff opened its doors in 1984 and strove to build a brand that is to wealth management as Tiffany’s is to jewellery or Rolls-Royce is to your ride. Clients needed to commit a minimum of $3-million. For that price, they became members of an exclusive club with breathtakingly modern offices, plenty of hand-holding on financial decisions and head-turning events. The firm’s party to celebrate the Barnes exhibit of paintings at the Art Gallery of Ontario in 1994 is still a high-water mark in Toronto society.

That cachet took a beating after founders Ira Gluskin and Gerry Sheff stepped down as executives in 2009, and left the board in 2013. The two executives turned around and sued their former company for $185-million, claiming unpaid benefits. An arbitrator eventually awarded the duo $13.8-million in 2017. The dispute was a distraction for both Gluskin Sheff management and the company’s customers, most of whom had ties to the departed leaders.

Investment performance also became an issue for some clients. Prior to Onex’s arrival, Gluskin Sheff was bleeding assets. It went four consecutive years with existing clients pulling out more money than new customers put in. The outflow of funds was $235-million last year and $236-million the year before.

Onex is attempting to turn the tide with a renewed commitment to service and new flavours of investment products. Gluskin Sheff is out recruiting, with plans to build a team of seven experts focused solely on estate and tax planning. Financial results released last week show Gluskin Sheff clients committed US$199-million to Onex’s credit-based funds in the three months ended Sept. 30 – the first full quarter after the deal – and an additional US$52-million to Onex’s private-equity offerings.

In total, Gluskin Sheff takes care of US$6.4-billion, including US$60-million from Onex’s own employees. In a recent report, analyst Phil Hardie at Scotia Capital said: “The outflows Onex saw at Gluskin Sheff during the first half of the year appear to have slowed significantly.”

Onex, like other private-equity companies, earns the bulk of its profits when it sells businesses, but this income is lumpy. In contrast, Gluskin Sheff generates a steady stream of management fees. The firm charges clients a 1.5-per-cent commission on portfolios, plus performance fees that range from 10 to 25 per cent of investment gains. Those fees will translate into recurring profits for Onex.

That, in turn, is expected to mean a premium valuation for the company’s stock, according to analysts. Last year, Onex collected US$199-million in management fees. Onex projects that acquiring Gluskin Sheff will boost the total to US$328-million this year.

Onex is far from the only private-equity player striving for greater scale and more fees from taking care of other people’s money. The drive to diversify is playing out at U.S. private-equity pioneers KKR & Co. Inc. – a firm launched by Mr. Schwartz’s former colleagues at investment bank Bear Stearns – as well as New York-based Blackstone and Toronto-based Brookfield.

Onex is relatively a minnow in this school of fish. KKR is four times larger when it comes to assets under management, while Blackstone and Brookfield are more than 10 times its size. In an increasingly competitive industry, asset managers want to accumulate as much cash as possible to do the largest possible transactions, on the theory that there are fewer rivals for the biggest deals.

Onex’s founder is the first to concede the massive amount of capital now committed to private equity makes it increasingly difficult to find attractive targets. In his talk to the CFA Society, Mr. Schwartz said when he started his career in the 1970s, the total amount of capital committed to private equity, globally, was about US$300-million. Today, there is US$2.5-trillion looking for deals. Onex alone is sitting on more than US$2-billion of what is known in the industry as “dry powder,” or capital it is looking to put to use.

“It is a very, very difficult market,” said Mr. Schwartz. He said many private-equity fund managers are willing to risk overpaying to buy businesses because they are “desperate to get invested and move on to the next fund raise.”

Onex is willing to row against the tide. While the company is still scouting for takeovers and working to close the WestJet acquisition – the airline’s shareholders approved the deal in July but it still requires a thumbs-up from regulators – the priority is selling stakes in businesses, to take advantage of public markets that are hitting record highs. So far this year, Onex has raised more than US$900-million for its own account and millions more for clients by parting with holdings in seven businesses, including U.S. fast-food chain Jack’s and Swiss packaging company SIG Combibloc Group.

Onex plans to invest more money in fewer sectors. Historically, the company’s 119-member investment team cast a wide net for deals. After what analysts describe as an “operational review” that concluded ahead of its investor day in October, Onex conducted an internal restructuring that narrowed its focus to just four areas: industrial businesses, service companies, health care and financial services. Scotiabank’s Mr. Hardie said: “These cores notably exclude the retail segment, which we believe has been a source of some of its recent challenges.” (The boardroom discussion of the decision to avoid retailers would have been fascinating, as Heather Reisman, chief executive of bookstore chain Indigo Books & Music Inc., is both an Onex director and Mr. Schwartz’s wife.)

Onex is in the midst of a market slump, and a grocery-store investment is partly to blame. Its stock price is up 7.3 per cent year-to-date, while shares in peers such as KKR, Blackstone and Brookfield soared by between 45 and 85 per cent. Analysts say Onex shares now trade at a 15-per-cent discount to the underlying value of the company’s assets. While this has happened in the past, there have also been times when Onex stock commanded a premium to the value of its holdings.

Analysts trace the negative sentiment to investor concerns over two business that are turning in disappointing financial performance, U.S. discount grocery chain Save-A-Lot Ltd., which Onex acquired in 2016 in a US$1.4-billion transaction, and British marine-equipment supplier Survitec Group Ltd., bought in 2015 for £450-million. Analyst Geoffrey Kwan at RBC Dominion Securities said the problems, while significant, are in Onex’s past. “Underperforming investments have been written down to almost zero, so any further deterioration should have minimal impact on Onex,” Mr. Kwan said. “Historically, the best times to buy Onex were when the shares traded at a discount to net asset value.”

Onex’s recent makeover also saw the company rework its structure. Analysts say the company got rid of “pods” of employees who were assigned to sectors, deciding the structure limited the opportunities for its staff to get to know how each company really worked. Instead, executives assign employees direct responsibility for specific investments, in a drive to increase accountability.

Formal responsibility for running the firm’s different units went to three Onex senior managing directors: former banker Seth Mersky, ex-Berkshire Hathaway executive Bobby Le Blanc and Anthony Munk, son of entrepreneur Peter Munk. Each executive is in his 50s and has spent more than two decades at Onex. Those looking for signs of succession planning would start with this trio.

Finally, Mr. Schwartz and his colleagues came out of the management sessions with what could be described as Onex’s private equity playbook, or the Gospel of Gerry. Scott Chan, a Canaccord Genuity analyst, summed up their efforts by saying Onex created a formal process for investing that included “a dozen key criteria predictive of investment success, such as cost-savings, growth projections, valuation of tax assets, etc. This will help adopt a more agile and targeted investing approach.”

Onex deal makers all have a story on Mr. Schwartz’s dedication to the company and his passion for deals. Five decades into his career, he still makes calls on Sunday nights, sweats the details of pitches to potential targets and clients, and pushes to expand the company. The founder’s recent moves speak to his legacy. By acquiring Gluskin Sheff and attempting to instill a shared, methodical approach to investing, Mr. Schwartz is attempting to ensure Onex will have the scale and culture required to sail on, long after he leaves.

01 November 2019

Derek Neldner, New Head of RBC Capital Markets Has Work Cut Out for Him

The Globe and Mail, Rita Trichur, 1 November 2019

Derek Neldner took the reins as group head of RBC Dominion Securities Inc. on Friday, and he’s got his work cut out for him.

Make no mistake: RBC’s capital-markets arm still defines the big leagues on Bay Street and is a Top 10 global investment bank. But these days, its bankers have a little less reason to swagger. Corporate clients are more cautious about deal making and borrowing because of uncertainties stemming from a slower U.S. economy, Brexit and high-profile trade spats.

While those trends are weighing on investment banks around the globe, RBC’s bragging rights are also in shorter supply because of its own foul-ups. A spate of regulatory smackdowns, mostly south of the border, are creating new reputational risks for RBC’s capital-markets division which once prided itself on being the Boy Scout of investment banking.

Mr. Neldner, 46, has plenty of cred on the Street. But he still faces a formidable challenge. Not only must he propel new revenue growth without excessive risk taking, he must also keep his bankers and traders on a tighter leash. And if that wasn’t enough, his outspoken predecessor, Doug McGregor, will still be looking over his shoulder – at least for the time being.

Mr. McGregor, 63, spent more than a decade at the division’s helm, and during that time, earned a reputation for his blunt talk and imposing personality. On Friday, he became chairman of RBC’s capital-markets division and will remain in that job until he retires on Jan. 31, 2020.

It’s hard to imagine Mr. McGregor holding his tongue, especially given the division’s challenges. During its fiscal third quarter, net income and revenue from RBC’s capital-markets division fell – both year-over-year and quarter-over-quarter.

Results were hurt by lower investment-banking revenues, lower equities-trading revenue, a slowdown in mergers and acquisitions activity and bigger provisions for impaired loans.

While Mr. Neldner can’t control those macro trends, shareholders will expect him to improve certain financial metrics. For starters, the capital-markets arm’s return on equity of 11.1 per cent is sagging relative to the bank’s other divisions including personal and commercial banking (28 per cent), wealth management (17.2 per cent) and insurance (39.2 per cent).

There will also be more pressure to control costs, including in the way RBC pays its bankers and traders. The capital-markets division’s ratio of total compensation to revenue – which includes a variety of compensation costs including salary, benefits, stock-based compensation and retention bonuses – stood at 37.9 per cent during the third quarter.

Mr. Neldner, meanwhile, is also heir to other headaches, including the fallout from cultural and conduct problems.

Last year, RBC abruptly dismissed Blair Fleming, then-head of its U.S. capital markets business, after an internal investigation found he allegedly violated company policies pertaining to workplace relationships.

Mr. McGregor later encouraged employees to 'speak up' when they see improper behaviour, an obligation that Mr. Neldner now inherits as regulators sharpen their scrutiny of misconduct risks at banks.

The division’s compliance issues have come to the fore again in recent months. In August, RBC agreed to pay a $13.55-million financial penalty to the Ontario Securities Commission to settle charges that it failed to supervise foreign-exchange traders over a three-year period.

Regulators alleged that traders used electronic chatrooms to share confidential customer information with their peers at other companies between 2011 and 2013. What’s more, the OSC alleged that RBC didn’t completely correct its chatroom compliance problems until 2015. (Toronto-Dominion Bank separately agreed to pay the OSC $9.3-million).

And just last month, the Commodity Futures Trading Commission (CFTC) slapped RBC with a US$5-million fine for 'failing to meet its supervisory obligations, which resulted in hundreds of unlawful trades and other violations' from late 2011 through May 2017. This was despite the fact that RBC was punished for similar compliance violations in 2014, when it was ordered to pay a US$35-million penalty for engaging in illegal futures trading.

There’s no understating how harmful blunders such as these are to RBC’s brand, especially after the Michael Lewis book Flash Boys lionized the bank’s do-gooder culture.

The bank made public-relations hay from the publicity for years. Perhaps, its executives’ biggest mistake was believing their own PR.

Mr. Neldner, who has worked his way up the ranks at RBC since 1995, is now responsible for mopping up such messes. The bank cannot afford more hits to its reputation. His troops will have to fall into line.

30 October 2019

National Bank is the Only Bank to Outperform the S&P/TSX Composite (YTD)

The Globe and Mail, David Berman, 30 October 2019

Among Canada’s Big Six banks, just one is trading at a relatively high valuation: National Bank of Canada. And that gives the stock one extra hurdle to clear as the fiscal year ticks down.

Over all, the biggest banks are on a roll after rebounding from a sell-off toward the end of 2018, with average gains of 13.3 per cent year-to-date.

But National Bank, the smallest of the Big Six, stands out as the clear winner. This year, the stock is up 21.2 per cent (not including dividends), outperforming its peer average by a remarkable 7.9 percentage points.

The second-best performer, Royal Bank of Canada, is up 14 per cent. The laggard of the group, Bank of Montreal, is up just 10.9 per cent. Another way of putting National Bank’s performance into context: It is the only big-bank stock that has outperformed the broad S&P/TSX Composite Index, which is up 15.2 per cent this year.

The source of the bank’s winning ways is no mystery: National Bank is focused on Quebec, while its peers are more diversified across Canada and internationally.

In 2018, 58 per cent of National Bank’s revenue came from Quebec, compared with 29 per cent from all other provinces combined (the remaining 13 per cent of revenue came from outside Canada).

This geographic concentration is a plus when the province’s economy is humming. In July, Quebec’s gross domestic product (GDP) increased for the 10th straight month, marking the best winning streak on record for the province. GDP has risen by 3.4 per cent (at an annualized rate, after inflation) over this 10-month period, which is far better than the 1.5 per cent GDP growth nationally.

“Quebec’s economy continues to churn out historically strong growth, and remains one of the most positive economic stories on the Canadian landscape,” Robert Kavcic, senior economist at BMO Nesbitt Burns, said in a note.

The province’s economic activity has been beating the national average for nearly two years. Quebec’s unemployment rate sits at just 4.8 per cent, versus 5.5 per cent nationally. And while low energy prices have weighed on Alberta, Quebec benefits from lower energy costs.

National Bank, then, is in the right place – and it has been making the most of it. Over the past three years, the bank has produced average annual profit growth (on a per share basis) of 10.3 per cent, versus a group average of 8.9 per cent, according to CIBC World Markets.

The bank is also making strong progress in controlling costs. Its efficiency ratio, which compares expenses to profit (lower is better) improved to 53.5 per cent in the third quarter, down from 55.8 per cent in the third quarter of 2017.

The problem? The stock is no bargain.

The shares trade at 10.8 times estimated earnings, according to Bloomberg. That’s higher than the 10-year average estimated price-to-earnings ratio of 10.2, according to data last week from RBC Dominion Securities.

National Bank is the only big-bank stock with a valuation that exceeds its long-term average: The other five stocks trade at discounts. Canadian Imperial Bank of Commerce, the cheapest, has a P/E ratio of just 9.3 (again, based on estimated earnings), versus a 10-year average of 10.

Most big-bank stocks are cheap for a reason: They have been struggling to produce meaningful profit growth amid a slew of challenges. Canadians suffer from high levels of indebtedness, loan losses are rising, low interest rates are crimping lending margins and the U.S.-China trade war is muddying the global economic outlook.

The big banks’ fiscal third-quarter results, released in late August and early September, showed that profits increased just 3.7 per cent year-over-year and they were flat from the previous quarter, according to DBRS, the credit-rating agency.

Most of the banks reflect this unattractive backdrop, with relatively low valuations. National Bank is the exception, and the stock’s higher-than-average valuation could be its biggest challenge.

26 July 2019

Reimagining RBC: How Canada’s Biggest Bank Is Tackling the Never-ending Threat of Disruption

The Globe and Mail, James Bradshaw & Tim Kiladze, 26 July 2019

Top executives at Royal Bank of Canada were feeling pretty confident in 2016 that a new retail strategy they were crafting would be groundbreaking.

Their plan, dubbed Vision 2025, would reshape the way they approached retail banking. A decade out, RBC imagined acquiring customers in bold new ways, including starting businesses that had very little to do with banking but would attract entrepreneurs and new immigrants. The bank also planned to rely more on digital apps to handle simple transactions – and to glean insights about client behaviour.

Then they landed in China.

On a reconnaissance trip, the executives were confronted with a cluster of digital behemoths such as WeChat already touching every corner of a consumer’s life. The popular messaging app lets users make payments and money transfers, book flights, hail a ride-sharing car or order food delivery, all from a mobile phone. From each of these services, WeChat learns more about its consumers’ lives in an era when customer data – once a domain in which big banks held a significant advantage – are increasingly valuable.

“As we met with Alibaba and the large digital firms there, [we realized] they’re already three years down this path,” recalls Neil McLaughlin, RBC’s head of personal and commercial banking. The harsh truth about RBC’s strategy to embed itself more deeply in all aspects of a customer’s digital life was laid bare: “This isn’t us innovating, this is us coming to the same conclusion that another market already got to."

Even more terrifying, he adds, was the pace of change. Chinese digital giants seemed to be moving five times faster than RBC.

For Canada’s largest bank, this raised the prospect of an existential threat. Retail banking is a profit machine for RBC, delivering nearly half of last year’s profit.

In Canada, it can seem as though the banks are too big to disrupt – they appear to have neutralized the initial threats from financial-technology companies, or fintechs, and weathered the first forays into financial services by Silicon Valley giants. Apple Pay, for instance, has been slow to catch on.

But RBC is still focused on addressing the threat, because it isn’t going away. As the bank celebrated its 150th anniversary in June, chief executive Dave McKay and Mr. McLaughlin spoke to The Globe and Mail about the challenges ahead, as well as their vision for what the bank, and the industry, might look like in 2035.

“We’re reimagining the role we play in a client’s life,” Mr. McKay said. “Because that role has been kind of fixed for 150 years, it was pretty straightforward. But now … barriers are breaking down between industries.”

RBC executives are consumed with imagining how clients’ habits might change as new technologies and tech companies transform how – and where – they spend their money. Why borrow from a bank to buy a car if, 10 years from now, Lyft offers a subscription service that meets most driving needs?

Then there is the “open banking” movement. The Canadian government is currently weighing new rules that make it easier for clients to move all their account info and data to startup financial institutions.

“Executives are rightly nervous,” said Paul Battista, the head of Ernst & Young’s Canadian financial-services consulting practice. “There is a lot of fundamental change going on right now … and it will be profound when it hits.”

Rising threats

One of the first things RBC tackled when revamping its retail-banking strategy was customer acquisition. For much of its history, banks pursued clients using traditional sales tactics, such as mailing millions of credit-card offers directly to Canadian homes or relying on branches to serve as large nets. Once clients walked in, staff could offer a variety of financial products.

In a digital world, signals of what’s going on in customers’ lives and where they’ll spend their money are increasingly showing elsewhere – on social media, through search engines and from online purchases. Although banks still gather a fair amount of information through transaction data, it is often not as detailed as data collected by tech companies. A credit-card statement might show a purchase from Amazon.com, but not what was purchased. In that instance, Amazon can gather far more intimate portraits of a customer’s intentions.

So the bank launched RBC Ventures in 2018, a startup accelerator of sorts whose businesses are designed to reach clients long before they consider a banking product. For instance, instead of advertising small-business loans, the bank built a new digital business in-house called Ownr that walks the user through all the steps necessary to set up a company – hoping that, eventually, the customer will borrow from RBC. Another app, called Arrive, provides step-by-step guides to help new immigrants get set up in Canada, giving the bank a way to reach prospective customers as soon as they touch down in the country.

That was just Step 1. RBC’s leaders are now working on a new strategy, dubbed Vision 2035, and no question is off limits.

“What does the consumer balance sheet look like [in 15 years]?" Mr. McKay wonders. Could the traditional approach that led RBC to accumulate $1.38-trillion in assets become less relevant – or even a liability?

"I don’t know. I don’t have an answer for you,” Mr. McKay said.

RBC’s leaders are also trying to anticipate the next wave of disruption. For one, as technology breaks down barriers between industries, Mr. McKay expects more customers may ask home voice assistants built by Apple, Amazon or Google, “What’s the best mortgage rate?” The machine might spit out a single search result and access to that customer could be sold by the voice-assistant maker to the highest bidder.

“How terrifying is that?” Mr. McKay said.

Meanwhile, Canada’s federal government is currently weighing the merits of so-called open banking. The movement, already established in Britain, is essentially a set of rules that will allow consumers to share and move their banking data from one provider to another, often with a swipe of a finger.

If it unfolds as expected, it could increase customer switching rates between financial institutions, loosening the grip incumbent banks hold on their customers – and that’s the last thing RBC, the largest of the Canadian banks, would want.

How RBC is responding

Risk-averse banks may seem ripe for disruption, but RBC contends banking is not simply about transactions and that its track record is hugely valuable.

“An awful lot of retail customer decision-making is emotional, not logical," Mr. McLaughlin said. Customers will subconsciously think, “I have an affinity for this brand, and I trust them.”

To better understand the way clients think, RBC began hiring ethnographers a couple of years ago. Ethnographers are trained to observe people in everyday situations and RBC sends them to visit customers’ homes and employees’ workplaces to explore the different relationships people have with money. At a basic level, Mr. McLaughlin explained, ethnographers “help what is a very logical industry think through, ‘Here’s how we need to speak and interact with customers.'"

The exercise has reinforced how vital brand loyalty is to RBC. So the bank is trying to expand the appeal of the banking bundle, adding on discounts, rebates, loyalty points and special offers to create as many reasons as possible to dissuade customers from taking any part of their business elsewhere.

RBC recently partnered with Petro-Canada to share some customer data, persuading clients to link their cards from the two companies by offering discounts at the gas pump. The bank also launched Ampli, a proprietary loyalty program in tandem with WestJet Airlines Ltd. and major Canadian retailers, that will offer perks and travel rewards designed to tie customers ever more closely to the bank, and aggregate their data.

The goal is to make customers question whether the grass really is greener at rival institutions, especially at fintech startups. "Are they going to offer cents off at the [gas] pump? Do they give me a discount on my mortgage?” Mr. McKay said.

At the same time, RBC is trying to expand the scope of what a customer does through their bank. Traditionally, a bank served a prospective homeowner with products, such as mortgages and lines of credit. RBC’s mission is to solve as many “pain points” associated with housing as possible, and “not just financing,” Mr. McKay said.

For instance, if RBC can refer a borrower taking out a mortgage to a real estate listings site, a moving company and a contractor to do renovations in the span of a few clicks, RBC will seem more indispensable to that client. “That’s where opportunity lies for banks and non-banks,” said Geoff Rush, a partner at KPMG Canada.

However, it requires rethinking the way these relationships are structured. “The interesting challenge is, in that end-to-end experience, who owns the customer?” Mr. Rush added.

Amid all this change, RBC’s leaders also plan to make full use of the bank’s size. Banks are already spending billions of dollars annually on new technology systems – RBC spends well in excess of $3-billion each year. But because it has annual revenues in excess of $42-billion, which leads all Canadian banks, it can spread those costs more widely across its business.

Last year, CIBC World Markets analyst Robert Sedran summed up RBC’s approach in two words: “Weaponizing scale.” In a note to clients, he wrote: “Not only does this bank have an advantage on the sector, that gap is growing.”

The major question is what all of RBC’s investments will add up to. Two startups tied to RBC Ventures – the financial-advice app Finfit and wellness app Carrot Rewards – have already shut down, proving how hard it can be to build a digital following and to run digital businesses. And some of that cash spent on digital experiments could have been returned to shareholders or poured back into improving existing businesses.

But RBC’s executives say they can’t risk giving digital challengers even the smallest chance to pluck away products and services that make banks valuable to their clients.

"We never want to give a customer a reason to go shop across the street," Mr. McLaughlin said.

24 April 2019

RBC Capital Markets Is Playing In A Different League Than Its Canadian Rivals

The Globe and Mail, Marina Okhromenko, 24 April 2019

It’s time to acknowledge that when it comes to investment banking, RBC Capital Markets is playing in a different league than its Canadian rivals. The deal-making arm of Royal Bank of Canada churned out $8.4 billion in revenue last year, almost as much as its second- and third-ranked domestic competitors put together. In the same way it seems preordained that football’s New England Patriots will be Super Bowl favourites every year, it now appears certain that RBC Capital Markets will make far more money than any other Bay Street dealer.

What's the secret to this run? Like the most successful coaches in sports, Royal Bank CEO Dave McKay says staying on top in increasingly complex markets starts with keeping things simple. “The beauty of the capital markets strategy is consistency and what I call the simplicity,” he said at a conference in March. “It is [built] around great people, using your balance sheet, creating value, advising and cross-selling, and it takes time to build up those relationships.” To use another gridiron adage, it's also about the team, rather than individual superstars. When that teamwork kicks in, it can turbocharge revenues and earnings.

Like many perennial winners, McKay pushes his team to do better each year, too. RBC Capital Markets earned a $2.8-billion profit in 2018, which translated into a healthy 13% return on equity—a performance any other Canadian bank would envy. But McKay isn't measuring his team mainly against Bay Street rivals such as Bank of Nova Scotia, which posted capital markets revenue of $4.5 billion in 2018. Royal Bank is competing against global players such as JP Morgan Chase, which generated $35.4 billion (U.S.) in revenue from corporate and investment banking.

RBC Capital Markets began to pull away from the rest of the Canadian bank-owned dealers in the late 1990s, when it found itself advising many of its Canadian corporate clients on international expansion plans. The division's leaders in that era, including long-time CEO Anthony (Tony) Fell, decided that to stay relevant to those clients, it needed to grow with them abroad, with an initial focus on the U.S. market.

In 2000, Royal Bank spent $1.5 billion (U.S.) to acquire a technology-focused investment bank, Minneapolis-based Dain Rauscher Corp. When the tech bubble burst in 2001, Dain Rauscher started losing money. Royal Bank also targeted relatively small growth companies, which was out of step with its focus on large-cap clients in established industries. Veteran real estate banker Doug McGregor was dispatched from the head office in Toronto to Minneapolis to turn things around.

McGregor and his colleagues stuck with a U.S. expansion strategy, but eschewed another acquisition, opting to take a slow-and-steady approach by hiring individuals and some entire teams from U.S. banks. They did the same with British, French and German rivals in Europe.

If Dave McKay is Royal Bank’s head coach, the role of quarterback falls to the 61-year-old McGregor, who’s chair and CEO of RBC Capital Markets and head of the bank’s investor and treasury services. A champion wrestler in his university days, McGregor looks like he could still pin an opponent, and he is disarmingly blunt and direct. He says the big-ego Masters of the Universe financiers made famous by author Tom Wolfe were never welcome at RBC Capital Markets. McGregor has hired 31 senior bankers in recent months, and says his goal in every interview has been ensuring the new partners are a “safe” cultural fit, which means “understated and team-oriented.”

As the bank has expanded internationally—RBC Capital Markets now has 3,300 employees in the U.S., 2,700 in Canada and 1,300 in Europe—McGregor and his colleagues say the concept of teamwork became more essential. No one player can do everything for large and complex corporations.

Take health care. Derek Neldner, RBC Capital Markets head of global investment banking, says that a generation back, one banker could be the sole contact with a pharmaceutical company. Now, he says, “if you are going to offer serious coverage to a health care client, you need an analyst who can talk authoritatively on medical devices, an expert on pharmaceuticals, one on biotech and so on.”

To cover the cost of employing all those specialists, a bank needs global scale, Neldner says. He adds that one of RBC Capital Markets' most significant internal accomplishments in recent years was devising a compensation system that ensures bankers and traders get paid for helping on a transaction even if they don't have direct ties to that client.

RBC Capital Markets' reach now vastly exceeds that of any domestic rival. The firm played a role in $1.5 trillion (U.S.) worth of syndicated loans last year, $74 billion (U.S.) in stock sales and $764 billion (U.S.) in bond offerings for Canadian and international clients.

Teamwork often boosts revenues, which is why McKay fixates on cross-selling. Jonathan Hunter, RBC global head of fixed income currencies and commodities, remembers working on an acquisition in British Columbia for a German client. Along with helping negotiate the deal, RBC arranged debt financing and used derivatives to hedge currency risk. “If our fee was a dollar on a conventional advisory assignment, we were able to earn a buck-sixty here by providing extra services while also doing a better job for the client,” Hunter says.

Size and outsized profits in capital markets also bolster the premium valuation for Royal Bank stock, analysts say. “When the waves pick up, we prefer to be on a bigger boat,” said CIBC World Markets analyst Rob Sedran in a recent report on Royal Bank. Like the Patriots, in good markets and bad, McKay’s team just keeps winning.

10 April 2019

Why Shorting the Canadian Banks on Housing Makes No Sense

The Globe and Mail, Tim Kiladze, 10 April 2019

When Steve Eisman warns about a downturn, investors listen – so his recent bet against Canadian banks is getting a lot of attention. Famous for his prescient call against the United States housing market before the 2008 global financial crisis, one of the fantastically profitable wagers profiled in The Big Short, Mr. Eisman, a fund manager, is now predicting trouble for Canada’s largest lenders.

He is very clear that he does not expect a U.S.-style housing collapse, yet he worries that Canada’s housing market is cooling quickly. Mr. Eisman also fears the fallout from a sluggish economy. Because the Big Six banks dominate domestic lending, he expects they will suffer.

It is a compelling story, one that other hedge funds have been making as well. The problem with the thesis, however, is that there are a number of holes in it.

From afar, the statistics about Canadian debt are jarring. Household debt has risen to 179 per cent of disposable income. The bulk of that debt is from mortgages, and the vast majority of these loans are financed by the Big Six lenders. So the banks look particularly vulnerable in any downturn.

But the specifics about the market structure matter, and Canadian fund manager Rob Wessel, who runs Toronto-based Hamilton Capital Partners Inc., has zeroed in on these in a new research note to push back against the short trade. The same is true for Australia, he argued, a country whose banking system closely resembles ours.

“While the housing story has not yet been fully written, we believe the ongoing corrections will remain orderly and that a ‘big short’ position in the Canadian and Australian banks will continue to be challenging,” he wrote.

Mr. Wessel has an interesting vantage point. His firm specializes in investing in financial institutions around the world, and he personally knows the Canadian market intimately after spending years as an equity research analyst who covered the domestic banks.

Crucially, he noted, healthy levels of collateral and mortgage insurance “provide huge buffers to direct losses for the banks." He isn’t completely dismissive of the short story, but he believes "it would take a truly significant decline in home prices for Canadian and Australian banks to incur a large increase in direct mortgage credit losses.”

Major Canadian banks have an average loan-to-value ratio of 54 per cent on their mortgage portfolios. That means if a buyer were to default, the bank should be able to repossess the home and sell it for far more than the remaining loan value.

Mortgage insurance provided by Canadian Mortgage and Housing Corp. is also a crucial element of the Canadian market, protecting the lenders when they’re issuing mortgages with smaller down payments. On average, 44 per cent of Big Six bank mortgages are insured, so the lenders are protected if borrowers on these insured loans default.

As for the argument that a sluggish economy will cause problems, Mr. Wessel notes that the national employment rate of 5.8 per cent hasn’t been this low in decades. The broad labour market strength should do wonders because loan losses are positively correlated with unemployment rates. Plus, for all the doom and gloom, Canada’s gross domestic product is still predicted to grow over the next two years.

Lately, bearish investors have cautioned that the expected economic expansion is smaller than recently predicted. Yet, Mr. Wessel writes, that means interest rate hikes will likely remain on hold, and that has started to push borrowing costs down.

Despite the vocal arguments made by fund managers such as Mr. Eisman, recent statistics show broad swaths of investors aren’t growing intensely bearish – at least not yet. Since the start of the year, total short interest in the Big Six banks has remained flat around US$10-billion, according to S3 Partners, a financial analytics company. Of these lenders, Canadian Imperial Bank of Commerce has the highest percentage of its float shorted, at 5.6 per cent.

But bank CEOs have still had to defend their institutions. On Tuesday, Bank of Nova Scotia CEO Brian Porter spoke at the lender’s annual meeting, and he provided a detailed riposte to the short narrative.

“We stress-test our portfolio on a regular basis, a daily basis. And we stress-test it against what we would view as very harsh metrics," he said, offering examples such as a 600-basis-point increase in interest rates and a huge jump in unemployment. Even in those scenarios, "our business is still profitable, the bank still pays a dividend, and we carry on.”

09 April 2019

Scotiabank Spending $300-million a Year in Anti Money Laundering Efforts

The Globe and Mail, James Bradshaw, 9 April 2019

Bank of Nova Scotia is spending about $300-million annually to combat money laundering even as it pulls out of some riskier markets, at a time when Canada’s government is promising new resources to fight financial crime.

The bank’s chief executive officer, Brian Porter, voiced support for an array of new measures unveiled by the federal government in last month’s budget, speaking to reporters after Scotiabank’s annual meeting of shareholders on Tuesday. The new initiatives are the government’s response to continuing criticism over significant gaps in Canada’s anti-money-laundering regime.

Scotiabank spent nearly $300-million enhancing anti-money-laundering capabilities last year, and expects to invest “pretty close to that in 2019," he said. And he acknowledged that Scotiabank is keenly aware of growing scandals over money-laundering lapses at two Nordic lenders, Danske Bank and Swedbank, that have claimed executives’ jobs, damaged those banks’ reputations and drawn heightened attention to global flows of illicit funds.

“This is a big issue and it’s one I think about a lot," Mr. Porter said. “We’ve all read in the papers about Danske Bank and Swedbank and what went on there."

Scotiabank spends more heavily on anti-money-laundering controls than some of its peers, partly as a function of its geographic footprint. Not long ago, the bank operated in more than 50 countries, from Russia and Turkey to the Caribbean and Latin America, many of which have been targets for those looking to wash illegal funds. Since Mr. Porter took over as CEO five years ago, the bank has sold businesses in some 20 countries, focusing the bank’s international footprint but also reducing its exposure to money-laundering risks.

Money laundering is only one risk factor the bank has looked to mitigate by “divesting some smaller markets. It’s a function of managing operational risk,” he said.

Scotiabank has made key hires in recent months to bolster its anti-money-laundering efforts, including naming Stuart Davis as its global head of financial crimes risk management. Mr. Davis was formerly the global chief anti-money-laundering officer at Bank of Montreal.

The bank had previously scaled back its metals business, ScotiaMocatta, having failed to sell the unit in 2017 after it was linked to a money-laundering scandal. In 2015, Scotiabank reached a written agreement with U.S. regulators to fix its oversight and monitoring of suspicious activity, correcting gaps in its compliance program.

Some estimates suggest that the total sums of money laundered each year add up to between 2 per cent and 5 per cent of global gross domestic product (GDP), or trillions of dollars, though it is hard to be precise about funds that exist in the shadows by their nature. “And this isn’t just drugs, it’s human trafficking, it’s all sorts of terrible things going on," Mr. Porter said, noting that banks have "an important role” to play in stemming the flow of such funds.

In recent years, Canada has received lukewarm ratings for its effectiveness at combatting financial crimes such as money laundering and terrorist financing. In response, the latest federal budget promised a series of investments and measures to try and “modernize” Canada’s regime to enforce anti-money-laundering laws.

The government promised to invest $16.9-million over five years in the Financial Transactions and Reports Analysis Centre of Canada (FinTRAC), and to boost the RCMP’s investigative capacity with tens of millions of dollars in annual funding. There are also plans to create an Anti-Money Laundering Action, Coordination and Enforcement (ACE) Team, drawing together experts from intelligence and law-enforcement agencies to boost co-operation.

“I think that’s good for the system, good for the country, and we’re supportive of that," Mr. Porter said.

08 March 2019

Big 5 Banks Led the 2009-2019 TSX Bull Market Run

The Globe and Mail, Tim Shufelt, 8 March 2019

On Day 1 of the recovery from the worst bear market since the Great Depression, the big Canadian banks led the charge on the Toronto Stock Exchange.

Royal Bank of Canada’s shares rose 14 per cent on March 10, 2009, as investors stormed back into the much-maligned financials sector. RBC’s fellow Big Five incumbents all posted double-digit gains of their own.

That day would prove to be the inflection point that separated the global financial crisis and devastating recession from one of the best bull markets in history.

It would also usher in a decade of bank dominance in the Canadian stock market, displacing resources as the main driver of domestic equities.

In the 10 years since the market bottomed out, the Big Five together have contributed nearly half of the total returns generated by the S&P/TSX Composite Index. Just five stocks contributed 47 per cent of a decade’s worth of gains in an index that contains around 240 of the country’s largest companies.

“The banking sector hasn’t really had a bump in the road in 10 years,” said Tom Bradley, president of Steadyhand Investments. “They’ve just had these howling tailwinds.”

But it’s hard to imagine those tailwinds being quite as intense in the years ahead. The burdens from indebted households, a moderating economy and a slowing real estate boom mean the next decade in banking, and bank investing, is unlikely to have the same sheen as the gilded decade past.

In the aftermath of the global financial crisis, Canada’s banking sector became the envy of the developed world. With relatively little exposure to the toxic securities that felled 25 U.S. banks in 2008 and destabilized the global financial system, Canada’s banks remained quite profitable. They didn’t even cut their dividends.

The World Economic Forum ranked the Canadian banking system as the world’s soundest, while U.S. President Barack Obama recognized Canada as “a pretty good manager of the financial system.”

While the banks themselves were spared from the worst of the carnage, their stocks fully participated in the crisis. Amid fears of contagion infecting the Canadian financial system, the diversified bank group declined in share price by 58 per cent from their 2007 peak to the market’s 2009 nadir.

“In a downturn, investors don’t look at earnings any more,” said Bill Dye, a banking analyst and portfolio manager at Leith Wheeler.

The combination of operational strength and cut-rate valuations set the Canadian bank stocks up for a monumental rebound. Citigroup Inc. provided the spark. After the company survived only by virtue of a bailout in the form of US$476.2-billion in cash and guarantees, Vikram Pandit, Citi’s beleaguered chief executive, told his employees on March 9, 2009 – the very day of the market bottom – that the bank turned a profit in the first two months of the year.

By the end of 2009, Canada’s group of big bank stocks had more than doubled. There was much more to come. Over 10 years, the banks have generated an average total return of more than 18 per cent a year. Not only did that performance trounce the broader Canadian stock market, it beat the S&P 500 index through the longest bull run in history. It even beat Warren Buffett – Berkshire Hathaway Inc. shares have returned 15.7 per cent a year over the same period.

Operating within a comfortable oligopoly, banks have undergone a decade of growth and become wildly profitable in the process. In fiscal 2018, the six largest banks generated $45.3-billion in earnings, amounting to more than $1,200 for each Canadian. They have thrived off of a generational housing boom, have come to dominate the wealth-management business in Canada and have used their domestic proceeds to expand well beyond Canada’s borders.

“They got through the crisis okay. They’ve grown their dividends. They put up these unbelievable numbers. What’s not to love?” Mr. Bradley said. In return, Canadian investors have developed a cult-like loyalty to the banks, which form the cornerstone of countless Canadian investment portfolios. “I get people that ask me, ‘Why wouldn’t I just own the five banks?’” Mr. Bradley said. That kind of radical concentration is one sign that sentiment toward the banks is overwhelmingly favourable, he added.

And yet, bank valuations never seem to get too out of hand. Despite their vaunted status among the investing masses, the big banks trade at an average forward price-to-earnings multiple of about 10.5. That’s considerably less than the valuation on the S&P/TSX Composite Index of about 15.

“Their valuations just don’t seem to get higher over time,” said Christine Poole, CEO of Toronto-based GlobeInvest Capital Management. “Some bank CEOs argue that they are fairly defensive and stable businesses, and ask why they’re not getting a higher multiple.”

But there is a good reason such highly leveraged businesses trade at a significant discount to the market. As a result of high leverage ratios, “when things turn down, the banks tend to get hit very hard,” Leith Wheeler’s Mr. Dye said. “Retail investors sometimes forget that.”

The financial crisis served up a good reminder of that, not that anyone’s anticipating Canadian bank stocks to face such a severe test any time soon. But the forces that have elevated the mighty banks since the financial crisis are undoubtedly weakening. With household debt near record levels, the average Canadian has little room left to borrow.

“Over the next few years, loan losses are likely to be higher than they are today, even if there isn’t a recession,” Mr. Dye said. “And earnings growth is almost assuredly going to be lower.”

22 February 2019

Comparison of the All-in-One Diversified ETF Portfolios

The Globe and Mail, Dan Bortolotti, 22 February 2019

In many aspects of our lives, we embrace convenience. We buy prepared meals instead of assembling and cooking the ingredients ourselves. We shop in malls rather than driving to four or five individual stores. We recognize our time is valuable and our mental bandwidth is limited, so we look for very good solutions, not perfect ones.

Except when it comes to investing. It’s the one area where simple, excellent options are available, yet too many people resist them because they’re too, well, simple. Here’s hoping a recent trend in the ETF marketplace will help investors overcome that tendency.

In the past year or so, all three of Canada’s largest exchange-traded-fund providers have launched products that allow investors to own a complete portfolio with just one trade. Each includes a mix of global stocks and bonds, so anyone with a brokerage account can get extremely broad diversification with minimal maintenance and rock-bottom costs.

Vanguard Canada was the first ETF provider to launch one-ticket solutions just over a year ago, and iShares followed in December. Earlier this month, BMO joined the party with its own family of all-in-one portfolios.

Let’s look at a typical example: the Vanguard Balanced ETF Portfolio (VBAL). Like its counterparts, it’s a “fund of funds” built using seven underlying ETFs. There are three for fixed income: one each for Canadian, the United States, and global bonds. Then there are four equity components: Canadian, U.S., international developed and emerging markets. Vanguard has estimated that the portfolio offers exposure to about 94 per cent of the world’s public markets.

VBAL has a long-term target of 40-per-cent bonds and 60-per-cent stocks, which is the traditional split for a balanced portfolio. But there are other options for people with different risk profiles, ranging from just 20-per-cent stocks in the Vanguard Conservative Income ETF Portfolio (VCIP) to 80-per-cent stocks in the aggressive Vanguard Growth ETF Portfolio (VGRO). All the funds have the same components, just in different proportions.

The iShares and BMO families are very similar. They vary in their specific holdings, but they all include a target allocation of Canadian and non-Canadian bonds, plus an equity mix with one-quarter to one-third domestic stocks, with the remainder split between the U.S. and overseas markets. In all, we’re talking about thousands of stocks and bonds from around the world, which is all the diversification anyone needs.

Moreover, as markets move in different directions and at different rates, the ETFs will be rebalanced so they maintain those long-term targets. This feature makes them virtually maintenance-free, and it puts some competitive heat on robo-advisers, the online services that charge about 0.50 per cent and advertise automatic rebalancing as one of their key benefits.

And the price tag for this elegant portfolio? The management fees range from 0.18 per cent to 0.22 per cent, which is about 90-per-cent cheaper than traditional balanced mutual funds. On a $100,000 portfolio, the monthly cost is a little more than you’re paying for Netflix.

The good news is that these all-in-one ETF portfolios have been embraced by many do-it-yourself investors: VGRO, for example, has attracted more than $570-million in assets in barely a year. But there has been resistance, too. I’ve heard from many investors who are concerned the funds are not optimized for tax-efficiency, or that you could reduce your fees even further by buying the underlying holdings individually. But how many honestly believe they can build and maintain a better portfolio? In the real world – where people are busy with work and family, and would rather watch the hockey game than fiddle with a spreadsheet – no one manages their portfolio optimally.

Others dismiss these funds as cookie-cutter solutions, or argue that they’re only appropriate for very small accounts or unsophisticated investors. What nonsense. I’ve reviewed a lot of portfolios over the years, with six- and seven-figure balances, many of which were designed by people who manage money for a living. Almost none of them were more thoughtfully structured than what Vanguard, iShares and BMO have packed into a single ETF.

Are these products right for everyone? Certainly not. Are they perfect? No, but neither is any other option. And here’s the thing: You don’t need an optimal portfolio, you just need an excellent one. No one has ever failed to meet their financial goals because they had exposure to only 94 per cent of the world’s stock and bond markets, or because they failed to keep their investing costs lower than 0.18 per cent. Countless millions have failed by trying to do better.

Eating well and staying in shape takes a lot of effort: It’s much easier to flop on the couch and order pizza. Learning to speak Gaelic, playing the trombone, nurturing a romantic relationship – these take a lot of work. But successful investing is the opposite: You usually thrive by doing less, not more. With the appearance of these all-in-one ETFs, building an extremely well-diversified portfolio has never been easier or cheaper. The only problem that lingers is the one in the mirror.

Dan Bortolotti, CFP, CIM, is a portfolio manager at PWL Capital in Toronto. He is the creator of Canadian Couch Potato, an award-winning blog about index investing.

18 February 2019

Preview of Q1 2019 Earnings

The Globe and Mail, David Berman, 18 February 2019

Canada’s biggest banks are set to report their fiscal first-quarter results starting this week, and once again the focus is on deteriorating economic conditions and slower loan growth – a theme that ran through the latter half of 2018.

Royal Bank of Canada will kick things off on Friday, when it reports results for the three-month period ended Jan. 31. Next week, Bank of Montreal and Bank of Nova Scotia will report their respective financial results on Tuesday, followed by National Bank of Canada on Wednesday.

Canadian Imperial Bank of Commerce and Toronto-Dominion Bank will conclude the reporting season with their results on Feb. 28.

On average, analysts are expecting profit to increase just 3 per cent for the Big Six banks, year-over-year, and a mere 1 per cent from the previous quarter.

The subdued forecast reflects dimming optimism for the Canadian economy.

Many economists believe that the Bank of Canada has put interest-rate increases on hold, at least for the first half of this year. While employment gains were strong in January, there are continuing concerns about the Canadian housing market – where sales in Vancouver and Toronto have declined – and the energy sector, along with global uncertainty regarding trade and even the waning strength of the U.S. economy.

Bond yields, which surged last year in anticipation of rate hikes, fattening bank margins on loans, have fallen substantially. While lower yields will reduce borrowing costs for consumers, they suggest that demand for loans could be tempered if the economy stumbles.

RBC Dominion Securities recently reduced its price targets on a number of Canadian bank stocks, arguing that the various headwinds will leave shares trading at subdued valuations (or relatively low price-to-earnings ratios).

“Our forecast for relatively slower EPS [earnings per share] growth for the banks in 2019 and 2020 largely reflects our view that continued deceleration in domestic loan growth will slow revenue growth,” Darko Mihelic, an analyst at RBC Dominion Securities, said in a note.

He expects that personal loan growth will slow to just 2.9 per cent in 2019, down from 4.1 per cent in 2018, as today’s higher interest rates and sluggish economy weigh on mortgage underwriting activity. As a result, he estimates that revenue expansion for the Big Six banks will slow to 4.3 per cent in 2019, down from 5.7 per cent last year (when adjusted for acquisitions).

But the first-quarter results, in particular, have something else pressing on them: Volatile markets. The S&P/TSX Composite Index, among other major indexes, fell sharply from the end of August through most of December, overlapping with the banks’ fiscal quarter.

Analysts expect that the declines will weigh on banking activities such as trading and asset management.

“Everything from mutual fund fees to underwriting revenues will likely have been down. Trading, as ever, is a wildcard, but we do expect a sequential decline on that line as well,” Robert Sedran, an analyst at CIBC World Markets, said in a note.

The good news? Dividends are set to rise. Analysts expect that RBC, Scotiabank and TD will boost their quarterly pay outs in keeping with their recent pace of increases.

As well, bank stocks, which were hit hard last year, are now recovering nicely. The Big Six are up more than 9 per cent in 2019.

The rebound suggests that share prices may have been reflecting concerns over the economy back in December, when bank stock valuations fell to their lowest levels since the financial crisis a decade ago, and are now anticipating an improvement over the remainder of the year.

Indeed, some analysts believe that the low profit growth for the big banks in the fiscal first quarter will mark a starting point from which the banks will add earnings power as the year progresses, as loan losses remain low, profit margins expand slightly and bank revenue grows at a faster pace than expenses.

Mr. Sedran expects that the Big Six will report earnings growth of 6.5 per cent for fiscal 2019. While that marks a notable slowdown from 12 per cent in 2018, it implies that earnings will improve after a weak first quarter.

“While we share at least directionally the market’s concerns about the age of the economic cycle, we are unconvinced that it will show its age in fiscal 2019,” Mr. Sedran said.

01 February 2019

RBC Lowers Outlook on Banks

The Globe and Mail, David Berman, 1 February 2019

Canadian bank stocks have rebounded over the past six weeks after touching their lowest valuations since the financial crisis. But an enduring recovery rests on profit and revenue growth over the year ahead, and the outlook here is murky at best.

For sure, the stocks are enjoying some momentum right now. The Big Six have risen 11.4 per cent since Dec. 24, when the stocks traded at just 9.2-times estimated earnings, the lowest price-to-earnings ratio in nearly a decade.

But in the run-up to the start of the banks’ fiscal first-quarter reporting season on Feb. 26, some observers see potential hurdles, given a slowing Canadian economy and weak lending growth.

“We anticipate the economy will pick up again in 2020 – but during the slower economic period in 2019, risks will be elevated,” Darko Mihelic, an analyst at RBC Dominion Securities, said in a note to clients.

He cut his target prices (where he sees Canadian bank stocks trading within 12 months) by an average of 7.7 per cent on Friday, suggesting dimming enthusiasm. His target on Bank of Montreal fell to $112 from $126 previously, marking the biggest revision. His target on Toronto-Dominion Bank fell to $83 from $92.

Okay, the new targets imply average gains of about 17 per cent over the year ahead, which sounds good. But the revisions also suggest that bank stocks may be cheap for a good reason, which other analysts have also pointed out.

Gabriel Dechaine, an analyst at National Bank Financial, noted last month that low valuations imply serious concerns about the Canadian housing market. Of particular note: Residential mortgage growth – just 3 per cent in November, year-over-year – has descended to its lowest level in more than 20 years.

“Low valuations alone won’t attract investors to the sector. Indeed, we believe early 2019 housing issues could weigh on re-rating potential at least until we see stabilization in housing prices/mortgage volumes etc.,” Mr. Dechaine said in his mid-January note.

Mr. Mihelic put some numbers to his concerns. He reduced his 2019 and 2020 profit outlook for five of the Big Six banks (since he works for Royal Bank of Canada, RBC falls outside his coverage), by an average of 1.6 per cent.

He also cut his valuation targets for four banks (excluding National Bank of Canada, which is being buoyed by a strong Quebec economy, where it generates 58 per cent of its revenue), each by 0.5-times earnings. For example, he now expects TD will trade at 11.5-times earnings, down from a prior valuation target of 12-times earnings. His target for BMO falls to 11-times earnings, down from 11.5.

“We are lowering our target multiples for a number of reasons including a softer economic outlook and rising recessionary risks/late cycle concerns which could potentially lead to higher provisions for credit losses (PCLs) under IFRS 9,” Mr. Mihelic said, referring to new financial reporting standards.

Some of his numbers are sobering. He expects that personal and commercial loan growth will subside to just 2.9 per cent in 2019, down from 4.1 per cent in 2018 and 5 per cent in 2017.

Although business loan growth this year should be much stronger, at 6.9 per cent, that would mark a substantial slowdown from 11.3-per-cent growth last year.

Investors can always hope that the big banks will be able to squeeze more profit out of their revenues by cutting costs and introducing new technology. But even here, Mr. Mihelic is anticipating far more modest gains ahead. He expects that the banks’ efficiency ratios, which compare expenses with profit (lower is better), will dip only slightly in 2019, to 54.6 per cent from 54.8 per cent in 2018.

The takeaway here? Low valuations aren’t a compelling reason to bet big on banks right now, unless you can handle some bumps. “While the medium-term outlook is shrouded by uncertainty, we still like bank stocks over the longer-term,” Mr. Mihelic said.

24 January 2019

TD Bank’s Bharat Masrani on Managing Through Chaos and His Bank’s Bright Future

The Globe and Mail, Trevor Cole, 24 January 2019

Since Bharat Masrani took over TD, the bank's adjusted income has soared 50%. Bankers like predictability, and a few things have stayed unchanged since late in 2014, when Bharat Masrani became the first person of colour to run a major Canadian bank. At the time, TD was the second-largest bank in Canada, and it remains so. Masrani’s unassuming middle-management wardrobe eschewed flashy cufflinks then, and his shirts continue to be buttoned at the wrists. And more than four years after his newsmaking ascendance, Masrani is still the only example of diversity at the top of Canadian banking. Aside from all of that, things look very different.

Banking has gone highly mobile. The economy appears tilted toward recession. Interest rates are climbing as oil has plunged. And there’s a destabilizing narcissist in residence at the White House who seems intent on cooking up trouble. None of that has unsettled Masrani. Since he took over, TD’s adjusted income has soared 50%, and Masrani’s calm demeanour suggests everything is fine. For the man who helped TD weather the storms of 2008, maybe there’s nothing more predictable or manageable than chaos.

Why did the stock prices of all the banks struggle so much in 2018?

Banks are a reflection of what happens in general economies, and there are a lot of macro headwinds in the world, such as trade, what’s happening to global growth, Brexit. In Canada, we’ve seen some numbers that would suggest that perhaps there are real issues. There are views emerging that we are in for a volatile period here. I think that is reflected in the valuations you see.

In a recent interview, you said, “We enter the new year with good tailwinds in our business. The economic prospects in Canada and the U.S. are positive.” Have you changed your view?

I have not changed my view. You are asking me why the markets are behaving the way they are. From a tailwinds perspective, look at what has happened in the past year. Economic growth has been strong in the U.S. and Canada, which is where most of our businesses are. Interest rates have started to normalize, and for banks, that is positive. If you look at unemployment, there are very strong numbers in both the U.S. and Canada. So there’s a lot of momentum on our side. But that doesn’t mean there are no headwinds.

Do you see specific challenges ahead?

Trade is the worrisome one. There are real issues with respect to China, for example, on technology transfer, intellectual property. But a prolonged trade war is never positive. I think that is a big headwind going forward, and my hope is that sensible minds prevail.

“Sensible minds"—that’s asking a lot of the Trump administration.

Listen, there are stylistic issues. Economies work in different ways. The U.S. is a major economic engine for the world. I’m so glad we have a trade agreement that is refreshed now. There are chapters in the USMCA that make sense that did not exist before.

What do you expect regarding interest rates in the coming year?

Normalization is good. What is the new normal—the ideal interest rate that allows for very good employment, and deployment of an economic system versus inflation? I think that is what the world is searching for. If we go too high and too quick, it's going to be negative. For any bank, very high interest rates are not good because they cause our customers and the companies that bank with us to suffer. So I worry about it. And I think there is still more to come by way of normalization.

You spoke recently of there being “a benign credit environment.” But consumer debt levels are very high. Do you have any concerns?

Consumer debt as a headline number is high. But a lot of the Canadian consumer debt is in mortgages. The mortgage regime in Canada is a lot different than in the rest of the world—what kind of down payments are necessary, the interest rate risk financial institutions assume.

You said it’s different. How would you characterize it?

It’s better. It’s more sustainable. You know, at TD, mortgages are the biggest asset class on our balance sheet. I think that’s a positive for the Canadian system and economy. More than indebtedness, I think if the unemployment number starts to inch up, that would be a big indicator of potential problems in the economy and, frankly, potential losses.

That’s inevitable, isn’t it?

Regarding mortgages, you and Ed Clark smartly got out of mortgage-backed securities prior to 2008.

TD used to be a major player in the business of “structured products,” and thankfully we decided to exit. I don’t think we could have predicted the whole world was going to fly itself into a mountain through those products, but that’s what happened. And we were out of it. That allowed us to build out our U.S. business more quickly, because other banks were otherwise occupied.

Do you think that decision is one of the reasons you’re in the seat you’re in now?

I’m sure there are lots of decisions that go into the seat I am in. You should ask my board.

GM recently announced the closure of its Oshawa plant. What do you think about the future of manufacturing in this province?

Of course there is concern. It is a terrible thing for any community to go through. But our system has a way of transforming itself, and some new jobs will appear down the road. Many years ago, folks would not have thought of Toronto as a hub for artificial intelligence engineering talent, and today it is a major, major centre. Our system, with democracy and openness, produces terrific ideas that turn themselves into big industries. I’m confident that will happen.

Let’s talk about oil and gas. How much has TD reduced its exposure to the energy sector since 2016?

Our exposure is less than 1% of our total gross loans. So that is not a big issue. I think it’s the second-order effects we should look at—what happens to individuals when jobs are lost, GDP and all that. All those issues, from a TD perspective, are manageable. But that doesn’t mean this is pain-free.

So you are focused on the current state of the oil patch and what they’re going through?

Of course I am. At TD, we are all for the low-carbon economy. We multiply our lending to that area. We are one of the largest green-bond issuers. I think we are the only Canadian bank on the Dow Jones Sustainability World Index. But we also acknowledge that trying to get there instantly is not feasible.

You’ve talked in the past about TD’s “unique” culture. What’s unique about it?

It’s a unique and inclusive and performance-driven culture. Diversity plays a big role. As a bank, we don’t make anything. We don’t make cars; we don’t make computers. Our business is based on people. So, for us it’s a very serious matter. We think driving a very positive culture is not only the right thing to do but also the only way to be successful.

How does the notion of diversity manifest itself at TD?

We start with the premise that, of course, it’s the right, moral thing to do. From a business perspective, unless we reflect the communities we serve, we will not be as successful. Unless we have the best talent out there, we will not be successful. It goes right through our training programs, our leadership development programs, what targets we set. Look at how many women, for example, we have on our board. I am very happy with the progress we’ve been making.

On the retail side, more than 80% of TD transactions take place via mobile apps or online, but one of your key initiatives has been to invest in physical branches. Why?

Listen, every new channel that gets introduced, people love it. And it multiplies the number of transactions. I’m happy to report we are the largest digital bank in Canada. And we are rated No. 1 by App Annie, which is the industry standard. But 70% of our customers in Canada visited a branch in the last little while. And what we do in our branches, how those branches look, the type of service we provide, the level of advice we provide, is a lot different than it used to be.

Does that mean more branches? More people in the branches? Different functionality?

The physical nature of the branch is changing. You go to some TD locations and say, “Really? This is TD Bank?” There are branches in Canada, for example, where there is no cash! There are stores in Manhattan where there are no humans. This is what customers want, so we will adapt. And there’s a science to it.

How are the needs of customers changing?

They want to touch the bank in the way they prefer to touch it. So they want the best digital experience. And when desired, they want a branch interaction. And there, people want more than a transactional relationship. They want more information, more advice. The issue of confidence is playing an increasingly important role. Am I confident of what my needs are going to be down the road?

Let’s talk about succession. When Ed Clark was CEO, he saw you as somebody to groom for an eventual rise up. Did you talk to him? According to research I’ve done, he targeted you. Because you know a lot about Ed Clark’s mind. Well my question is, are you doing that for someone else?

You know, succession planning in a bank of TD’s size is always an important issue—at every level in the organization, not just my role. It’s a big board responsibility. It’s an ongoing exercise, and I think our bank does a pretty good job at it.

You don’t want to tell me whether or not you’ve got your eye on someone?

That's for you to find out.

09 January 2019

Banks Brush Off New Capital Rules, Saying They Have ‘No Impact’

The Globe and Mail, James Bradshaw, 9 January 2019

The chief executives of Canada’s largest banks are shrugging off tougher capital requirements introduced by the banking regulator, saying the change will have no impact on plans for acquisitions, dividend hikes or share buybacks.

Last June, the Office of the Superintendent of Financial Institutions (OSFI) revealed for the first time that the country’s six largest banks must hold extra capital, called the “Domestic Stability Buffer,” as an added cushion to help them cope in the event of an economic downturn. The regulator promised public updates on the buffer at least twice a year, and at its first opportunity in December, chose to boost it to 1.75 per cent from 1.5 per cent of a bank’s risk-weighted assets, starting April 30.

The move caught investors and analysts by surprise, as OSFI highlighted “systemic vulnerabilities” in Canada’s economy, suggesting that it is watching closely for signs of strain. Analysts speculated that OSFI’s swift move could fuel expectations that the buffer would continue to be nudged higher, adding to constraints imposed on banks since the last financial crisis.

But at a conference in Toronto on Tuesday, the CEOs of Canada’s big banks responded with a collective yawn.

“It doesn’t change anything,” said Toronto-Dominion Bank CEO Bharat Masrani.

Bank of Montreal CEO Darryl White said he sees “no impact” on the way he manages the bank, even if OSFI were to reduce the required buffer again, “because we wouldn’t chase them down.”

Royal Bank of Canada CEO Dave McKay said RBC will continue to “manage our surplus capital with the same margins," and Canadian Imperial Bank of Commerce CEO Victor Dodig said the move “hasn’t changed our view on what is the right level of capital for CIBC.”

An OSFI spokesperson declined to speculate on “future actions by the banks should stress conditions materialize,” but said that banks “are responsible for their own capital management strategy.”

In recent public comments, OSFI officials have voiced concerns over high household debt relative to incomes and uncertainty about housing markets, even as bank executives insist that Canada’s economic fundamentals are still sound. In raising the required buffer, OSFI assistant superintendent Jamey Hubbs said that “in light of positive credit performance and generally stable economic conditions, now is a prudent time for banks to build resilience against future risks to the Canadian financial system."

Currently, Canada’s Big Six banks must keep their common equity Tier 1 (CET1) capital ratios – a key measure of a bank’s resilience – at or above 9.5 per cent. That consists of a base level requirement of 4.5 per cent, a 2.5-per-cent “capital conservation buffer,” an extra 1-per-cent surcharge because of their size, plus the newly disclosed Domestic Stability Buffer. After April 30, the minimum will be 9.75 per cent.

Yet Canada’s six biggest banks had CET1 ratios ranging from 11.1 per cent at Bank of Nova Scotia, which recently completed a string of acquisitions, to 12 per cent at TD, as of Oct. 31, and appear to believe they’ve built adequate reserves.

“We’re so massively ahead of the buffer anyways, it doesn’t change anything,” said National Bank of Canada CEO Louis Vachon.

08 January 2019

RBC, BlackRock Team Up to Create Canada’s Largest ETF Brand

The Globe and Mail, Tim Kiladze & Clare O'Hara, 8 January 2019

Royal Bank of Canada and BlackRock Inc. are joining forces to sell exchange-traded funds, forming a rare partnership between Canada’s largest asset manager and the country’s biggest ETF provider.

Under the brand RBC iShares, the firms will create and market ETFs, which are best-known as passive investments that track major indexes at lower fees than most mutual funds. The new brand will be the biggest in Canada, based on assets under management.

For RBC, the partnership is a way to bolster its competitive position in the race to gather ETF assets. Save for Bank of Montreal, Canadian lenders have been slow to embrace ETFs – even as investors have increasingly used them to fill at least a portion of their portfolios.

By teaming up with RBC, BlackRock will gain better access to a distribution network. Despite a wave of digital disruption in financial services that has helped ETFs emerge as a popular do-it-yourself investing phenomenon, the vast majority of investment funds are still sold through advisers in Canada – and RBC manages one of the largest adviser networks.

“There is an industrial revolution happening in asset management,” said Martin Small, the head of iShares in Canada and the United States, in an interview. “The modern portfolio is going to be different than the portfolio of yesteryear.”

The partnership is BlackRock’s means to keep up with all of the change. RBC also runs the country’s largest asset management business, and BlackRock will lean on its expertise to create ‘active ETF’ strategies. The iShares brand is best-known for simple index-investing, such as the S&P/TSX 60 Index ETF, which is the biggest ETF in Canada and tracks the largest companies on the Toronto Stock Exchange for only 18 basis points annually, or 0.18 per cent.. However, the ETF market has become commoditized. To stand out, fund providers are creating more complex products that cost investors a little more money.

Damon Williams, RBC’s head of global asset management, said in the interview that RBC’s move signals a realization that investor preferences have evolved.

“ETFs, there’s no question, have become a growing part of the Canadian investor landscape,” he said. “We want to make sure we continue to be relevant to those investors.”

Amid this shift, both firms were at risk of losing their leading market positions.

BlackRock manages US$6.3-trillion globally, and iShares is one of the strongest brands known to both Canadian investors and advisers. The company has almost $57-billion in ETF assets in Canada, making it the market leader here.

But in recent years BlackRock has battled a growing number of competitors. Large mutual-fund firms, which sat the sidelines of the ETF market for many years -- including major independents such as AGF Investments and Mackenzie Investments and most banks -- have entered the market in the past two years.

Today, BlackRock remains the top ETF provider in Canada, but the new entrants have stolen market share. While BlackRock used to control more than 80 per cent of Canada’s ETF market, its position has dwindled to 36 per cent, as of Dec. 31, 2018, according to a report by National Bank Financial. Second place goes to Bank of Montreal, which is the one bank that got ahead of the trend and now has $48.6-billion in ETF assets under management.

RBC is navigating its own increasingly complicated competitive landscape. Canadian banks saw their earnings soar over the past decade as interest rates fell to near-zero, spurring a lending boom. Lately, however, benchmark central bank rates have started to rise, which makes borrowing more expensive. At the same time, baby boomers are hitting retirement age and this demographic bulge is seeking investment and wealth advice. Across the Big Six lenders, wealth management is seen as the next big potential profit driver.

Although RBC already has a large asset management business, with $369-billion under its watch in Canada, it has been missing an avenue to provide clients with low-cost index investing.

Because of their size in their respective fields, BlackRock and RBC are able to spread management costs across billions of dollars in assets, helping them gain a market advantage by lowering costs for investors. But global fund giants are starting to innovate. Fidelity Investments, for one, recently launched no-fee funds as a way to bring new investors in the door.

“Both firms had a lot of scale. But both of us are in a bit of the buy-versus-build mode,” ” BlackRock’s Mr. Small said, noting the companies began talks in mid-2018 as they started to believe that a joint venture would produce the fastest results.

Mr. Small suggested BlackRock could have hired more people or acquired an asset manager to create new types of ETFs, such as in-demand funds that cater to unique market characteristics, including volatility and momentum. “But it would take years to build that business in Canada,” he said.

Meanwhile, RBC had the opposite need. Canadian investors and financial advisers are shifting away from traditional mutual funds as they pour more money into ETFs, which were set to outpace mutual funds sales in 2018.

“RBC saw the need for more traditional indexing in its core portfolio and said, ‘We could build it, too,’” Mr. Small said. But again, time is of the essence.

While the partnership is unique and the first of its kind for ETFs in Canada, the wealth management sector was built on joint ventures. In the mutual-fund market, it is common for banks to sell funds under their brand names, but for the fund managers to be external. Such relationships are known as sub-advisory mandates.

BlackRock has announced a partnership in Canada in the past – albeit in a much smaller capacity. In 2017, the firm teamed up with Bank of Nova Scotia’s Dynamic Funds arm to launch five actively managed funds sold directly through advisers.

While the new RBC partnership has elements of a full-blown merger, the two firms will remain separate legal entities while operating a combined business branded as RBC iShares that will include 106 iShares funds and 44 RBC ETFs. The partnership will be overseen by a joint executive steering committee, with an equal number of representatives from BlackRock and RBC.

Under the new brand, the majority of the iShares ETFs and RBC ETFs will remain as is, with no formal changes to either name or ticker symbols. But most will be marketed as “RBC iShares,’ and the new entity plans to launch additional co-branded ETFs in the near future.

Fees for all of the ETFs will be divided between the two asset managers, with the split varying on the type of fund and how much each firm put into it. ETFs sold through RBC advisers, for instance, could deliver a bigger cut to RBC.

07 January 2019

RBC Devoted to Slow-but-Steady Approach to Becoming International Powerhouse in Investment Banking

The Globe and Mail, Andrew Willis, 7 January 2019

Doug McGregor contends that he knows exactly what it would take to quickly vault Royal Bank of Canada’s capital markets business into the very top ranks of global investment dealers.

“All we would have to do is take on more risk, or accept lower profitability,” Mr. McGregor says. And as he begins his second decade as CEO of RBC Capital Markets, Mr. McGregor is quick to explain why he has absolutely no interest in either strategy as he continues a slow-but-steady push to build Canada’s largest investment bank into an international powerhouse.

RBC is grinding its way to the top of the mountain. By a number of measures − lending, advising on takeovers − the dealer now ranks among the top 15 players worldwide, with aspirations to climb higher. Parent Royal Bank is a top-10 global player by most measures. But the 61-year-old CEO says growth is always about improving bottom-line results and "we never set targets based on market share.”

Over a four-decade career in finance, Mr. McGregor watched a series of rivals, including Royal Bank of Scotland, Deutsche Bank and most memorably, Lehman Brothers, expand rapidly by aggressively deploying their own capital and diving into new sectors and regions. None built platforms and cultures that could survive a market downturn.

Having had a front-row seat for the global financial crisis when he began his tenure as CEO in 2008 has clearly shaped Mr. McGregor’s approach to expansion. Over the course of an hour-long interview on the bank’s global growth strategy, the CEO uses the word “safe” at least a dozen times. RBC is recruiting aggressively in the U.S. and Europe − landing 31 senior bankers in recent months − but Mr. McGregor says the bank’s goal is to ensure new hires are a “safe” cultural fit, which means “understated and team-oriented.” RBC is spending hundreds of millions on technology and compliance, to ensure "we keep out of trouble.”

The quick route to expansion into new markets is through acquisitions. It’s a proven tactic in manufacturing, where you’re buying factories, but far more difficult to execute in investment banking, where the asset you acquire goes up and down the elevator each day.

RBC tried to bulk up in the United States in 2000 by buying Minneapolis-based brokerage Dain Rauscher Wessels, which catered to technology companies. Looking back on the move, Mr. McGregor said it proved difficult to integrate the U.S. firm’s focus on small capitalization companies with RBC’s expertise in serving large corporate clients. On Mr. McGregor’s watch, RBC has eschewed acquisitions, opting instead to hire individual bankers or teams from the largest U.S. and European firms, and build organically around these financiers.

RBC now has roughly the same number of bankers in the Canada and the U.S. − there are 3,000 employees in the home market and 2,800 in the U.S. − along with 1,100 staff in Europe and 113 bankers in Australia. Everyone covers the same sectors.

The next step in RBC’s growth plan is to back bankers outside Canada with the capital and services they need to deepen relationships with global clients. It’s a subtle transition, but one that can be hugely lucrative.

A decade back, RBC’s European bankers would have targeted secondary roles in deals. For example, they would strive for a role as one of a dozen big banks lending money on a takeover, in a process known as syndication. On these sorts of deals, fees are minimal and profits are measured in fractions of a percentage point.

By upgrading talent and committing more capital, RBC moved to the centre of the action. RBC advised on tactics and lined up financing last year on an £8-billion ($13.6-billion) takeover of GKN PLC by Melrose Industries, the largest hostile British deal in a decade. In the U.S. market, RBC was a leading player last year in transactions from some of the world’s largest companies, including The Walt Disney Co., T-Mobile USA Inc. and Blackstone Group L.P. Roles like these translated into an impressive 17 per cent return on the investment dealer’s capital.

In 2008, Mr. McGregor’s first year at the helm, RBC’s capital-markets unit earned $1.2-billion. Last year’s profit was a record $2.8-billion − more than the second and third largest Canadian investment banks put together. But sticking to his theme of safe growth, Mr. McGregor points out that the group’s profits are consistently less than 25 per cent of RBC’s total earnings. That’s right at the median point for investment-banking earnings at the six largest Canadian banks, which means Royal Bank’s exposure to sometimes volatile capital markets is in line with that of domestic rivals.

For the CEO, building a global business one banker and one client at a time translates into endless hours on an airplane. In the four weeks ahead of a brief Christmas vacation – he planned to golf in South Carolina – Mr. McGregor made business trips to Australia, Britain, San Francisco, New York and Montreal. He’ll be back on the road in early January, grinding out a proven growth strategy.

02 January 2019

Bank Stocks Have Seldom Looked This Enticing

The Globe and Mail, David Berman, 2 January 2019

Add Canadian banks to the long list of stocks that delivered dismal returns in 2018. But some encouraging developments have emerged from the sell-off: Valuations are low and dividend yields have risen to 4.6 per cent on average, pointing to a good buying opportunity right now.

First, let’s recap what happened in 2018.

The Big Six bank stocks fell by an average of 12 per cent (not including dividends). Or, if you look at the S&P/TSX Composite Diversified Banks industry group, which tracks all six banks but weights them according to market capitalization, the bank stocks fell 11.2 per cent last year.

The group delivered strong profit growth of 13 per cent, year-over-year. And the banks hiked their quarterly dividends by an average of 7.9 per cent, continuing an impressive clip.

But none of this apparently mattered: Share prices fell amid weak oil prices, low mortgage growth and signs of a slowing global economy.

Canadian Imperial Bank of Commerce was the weakest of the Big Six banks, declining 17 per cent as concerns persisted about the Canadian economy and housing market, and pushing aside Bank of Nova Scotia as the year’s lagging bank stock after CIBC took a particularly sharp downturn in December.

Toronto-Dominion Bank was the best performer, but nonetheless declined 7.9 per cent. Royal Bank of Canada was a close second, with a decline of 9 per cent.

Falling share prices and rising profits translate into tempting valuations, though. According to research from RBC Dominion Securities, the Big Six trade at nine times estimated 2019 profits. That’s a bargain next to the 10-year average price-to-earnings ratio of 11.1. CIBC, the hardest-hit bank stock in 2018, trades at a mere eight times estimated profit.

Dividends are also enticing. The Big Six yield an average of 4.6 per cent, led by CIBC at 5.3 per cent. That’s hard to ignore when the yield on the Government of Canada five-year bond is back below 1.9 per cent.

There are various ways to approach the bank sector, but nothing really worked in 2018.

The strategy of buying the prior year’s worst-performer – Bank of Montreal for 2018 – outperformed the sector by one percentage point last year, which is okay if you ignore the fact that BMO fell 11.3 per cent. (For this strategy, we use returns from the biggest five banks, which declined an average of 12.3 per cent last year). Let’s hope that CIBC, the pick for 2019 using the laggard strategy, performs better this year.

Exchange-traded funds that focus on the Big Six provide instant diversification and regular rebalancing for a relatively modest fee. Unfortunately, these ETFs failed to deliver sector-beating returns last year.

The BMO Equal Weight Banks Index ETF (ticker ZEB) holds all six bank stocks in equal amounts and rebalances regularly. This means that if one bank stock lags the others, the ETF manager will buy it in order to maintain the right balance. It also means National Bank of Canada has the same weighting as giant Royal Bank of Canada.

The ETF declined 11.8 per cent in 2018. That’s in line with the 12-per-cent average decline for the Big Six, but slightly worse than the 11.2 per cent decline for the S&P/TSX Composite Diversified Banks industry group.

The RBC Canadian Bank Yield Index ETF (RBNK) weights the Big Six banks according to their dividend yields – the two highest-yielding stocks each receive a 25-per-cent weighting, followed by a 16.7 per cent weighting for the next two stocks and an 8.3 per cent weighting for the last two stocks.

That’s an appealing approach for dividend-loving investors. However, the ETF declined 12.5 per cent in 2018. Dividends ease the pain, but not enough to make the fund a winner.

Discouraged? Don’t be. Canadian big bank stocks have a remarkable track record of rebounding from sell-offs. Whether you invest in one stock or a basket of stocks, cheap valuations should work in your favour in 2019 – and you’ll be collecting a handsome dividend while you wait for the rally.